Kingsoft Corporation Limited

Thank you, operator. Ladies and gentlemen, good evening and good morning.

I would like to welcome everyone to our 2020 third quarter earnings call. I'm Francie Lu, the IR Director of Kingsoft.

I would like to start by reminding you that some information provided during the earnings call may include forward-looking statements, which may not be relied upon in the future for various reasons. These forward-looking statements are based on our own information and information from other sources, which we believe to be reliable.

Please refer to the other publicly disclosed documents for detailed discussion on risk factors, which may affect our business and operations. Having said that, please allow me to introduce our management team who joined us today.

Mr. ZOU Tao, our Deputy Director and CEO; Mr.

Francis Ng, our Executive Director and CFO. Now I'm turning the call to our Executive Director and CEO, Mr.

ZOU. ZOU Tao?

[Foreign Language]

[Foreign language] I'll translate for Mr. ZOU.

We maintained a steady performance in the third quarter of 2020. Our outstanding results are mainly attributed to the increasing market recognition of Kingsoft Office Group, as well as our continued innovation in premium games.

Regarding Office software, Kingsoft Office Group's licensing business and servicing [ph] services have been growing year-on-year. We continue to explore technology enhancement in the Office software industry, optimize our user experience and strengthen our competitive advantages in online collaborative Office products.

In the online game sector, we will further pursue product innovation and enhance our capabilities in product development and operations, so as to extend our game categories. In the third quarter, our total revenue reach RMB1,397 million, a 034% year-on-year [ph] showing strong resilience despite the impact of the pandemic.

Both of our Office software and services and other businesses, as well as online game business have maintained strong revenue momentum, as they were up 59% and 19% year-on-year, respectively in the third quarter. Now, I'm turning the call to our Executive and CFO, Mr.

Francis Ng.

Hi, thank you, Francie. Hi, everyone.

I'm pleased talk to you again. In the third quarter, we saw significant growth in the Office software and service and other business.

Office software and licensing business from government and enterprise clients maintain its rapid growth. Kingsoft Office Group has further enhanced its service and brands and brings in several regional government and enterprise market as we continue to strengthen our technology capabilities and marketing efforts.

We have also established close cooperation with the leading customer in the traditional industry, such as Shaanxi Heavy-duty Motor Company and Joe Chan, iron and steel group. Kingsoft Office Group organized the second Office application developer conference in the third quarter of 2020 and brought together a diverse group of around 200 developers in the ecosystem.

Kingsoft Office Group has launched innovative office product, such as WPS Online PI, and WPS Document Writing during the period. And we fully integrated a Linux version and Sogou input method into our WPS for Linux addition.

Kingsoft Office has also acquired the Beijing Xu Wei [ph] technology company, in the third quarter. Going forward, Kingsoft Office Group and Xu Wei collaboration, technology and product development will drive a fixed layout document format standards for government and enterprise customer.

For those who are not familiar with this fixed layout document, you can refer to the PDF format, similar one. During the quarter, Kingsoft Office Group's personal subscription services maintain its rapid growth year-on-year.

And we continue to explore the innovative channel for marketing, such as live streaming ecommerce. By launching new products and services such as PPT design menu, we aim to enrich your platform contacts and enrich user reputation for those [ph].

In addition, WPS Doc has become the official Office software supplier for the 31st Summer World University Games. And we launched a WPS Doc Education Edition.

Kingsoft Office also entered into a SmartOffice cooperation framework agreement with Tsinghua University, which further strengthened our presence in the different market segments. In the third quarter, revenue from online games business, which RMB788.3 million [ph], representing a 19% growth year-on-year, mainly attributable to the continuous growth of the Flagship JX Online III PC game.

In August 2020, we celebrated 11th anniversary of JX Online III PC game and share with the gamer the latest development of this technological innovation and content creation. In addition, we introduce a development plan in the frame and television, music and animation through [indiscernible] which will have to further increase its user base and build long term growth potential to our core IP.

In October 2020, we launched our Feng Tian Zheng Dao, the anniversary expansion pack for JX Online III PC game. With a new season and enriched content which foreplays a better gaming experience.

In addition, JX Online mobile game has been renamed as a New JX Online I [Foreign Language] with an all-new game appearances and received positive feedback from the players. I will now discuss our Q3 operational and financial results using RMB as a currency.

Revenue increased 34% year-over-year, and decreased 2% quarter-over-quarter to RMB1,397 million. The revenue split was 56% for our online games, and 44% for office software and service, and others.

Revenue from our online game business increased 90% year-over-year and decreased 9% quarter-over-quarter to RMB700 million; the year-over-year increase were mainly attributable to the robust revenue growth from factored game, JX Online III, as we focus on providing high quality gaming content and innovative gameplay for better user experience. The quarter-over-quarter decrease was largely due to the decline in revenue from JX Online III, as a large scale expansion pack being successfully launched in the second quarter 2020, which was partially offset by the revenue contribution from the newly-released mobile games.

Revenue from Office software and services and others increased 59% year-over-year and 11% quarter-over-quarter to RMB 609 million. The year-over-year increase was largely due to the fast growth in both licensing business and subscription services of Kingsoft Office Group, driven by the increased paid user resulting from continuously improved product and services.

The quarter-over-quarter increase was due to licensing business driven by the solid demand from government and enterprise. Cost of revenue increased 9% year-over-year and 10% quarter-over-quarter to RMB240 million.

The increases were mainly due to higher server and bandwidth service fees associated with increased user traffic. Gross Profit increased 40% year-over-year and decreased 4% quarter-over-quarter to RMB1,158 million.

GP margin increased by four percentage points year-over-year and decreased by two percentage points quarter-over-quarter to 83%; the year-over-year increase in the Group's gross profit margin was mainly due to the change of sales mix and improve in operating efficiencies. Net R&D cost increased 25% year-over-year and 24% quarter-over-quarter to $484 million.

The year-over-year increases were mainly attributable to the increase headcount as well as the personnel related expenses. This is because we continuously strengthen the development of our new products and services, as well as technology updates.

The quarter-over-quarter increase was mainly due to increased personnel related expenses, as well as temporary exemption or reduction of a social and medical insurance premium for large enterprise, which was started from implementation from July 2020 [ph]. Selling and distribution expenses increased 14% year-over-year and 15% quarter-over-quarter to RMB221 million and the increase were largely due to the increased channel causes of Kingsoft Office Group, aiming to strengthen divisional [ph] technical service capability and branch inputs.

Administrative expenses increased 27% year-over-year and 16% quarter-over-quarter to RMB170 million. The year-over-year increase were primarily due to the increased staff related expenses and professional services fees.

To accommodate for the rapid growth of our business, we moved to a new office building in Beijing, which largely increase winter expenses and the quarter-over-quarter increase was attributable to the increased staff related expenses. Share-based compensation costs decreased 12% year-over-year and 15% quarter-over-quarter to RMB31 million.

Operating profit before share based compensation increased 97% year-over-year and decreased 33% quarter-over-quarter to RMB393 million. Net other gains were RMB368 million compared to a gain of RMB5 million in the corresponding period of last year and the losses of RMB105 million in the second quarter 2020.

The gain in the third quarter of 2020 were mainly due to debt we recognized a gain on deal [ph] disposal of Kingsoft Cloud as a result of the balance sheet impact of the issue of the new share in this quarter. The losses in the second quarter 2020 were primarily due to loss on deal disposal of an associate an impairment collision of certain industry [ph] companies.

We recorded share of profit of associate of RMB12 million compared to share profit of RMB128 million for the third quarter of 2019 and the share of losses of RMB173 million for second quarter 2020. The profit in the third quarter 2020 were mainly attributable to the gain recognized into the mobile partially offset by the losses recognizing of Kingsoft Cloud and the profit in the third quarter of 2019 were mainly due to debt, Cheetah Mobile recognized a gain on disposal of subsidiary exact [ph] quarter.

The losses in the second quarter of 2020 where mainly due to the losses recognizing Kingsoft Cloud which were also partially offset by the property recognized into the mobile and into the disposed share in certain invested company in that quarter. Income tax decreased 63% year-over-year and 88% quarter-over-quarter to RMB10 million.

And the last for period from a discontinued operation from the first quarter of 2019 reflected notice from Kingsoft Cloud, which was loss of RMB468 million. Profit for the period from discontinued operations on second quarter 2020 reflected the combination of the net loss and net gain on deal disposal of Kingsoft Cloud, which was a profit of RMB8,927 million.

And the net gain on deal disposal of Kingsoft Cloud was RMB9,096 million, recognized in the second quarter 2020 which was [indiscernible] separate listing of Kingsoft Cloud. As a result of the reasons discussed about profit attributable to the owners of parent, including that from the continuing operation and a discontinued operation for the third quarter of 2020 increased RMB1,700 and 49% year-over-year and decreased 93% quarter over quarter to RMB667 million Profit attributable to the owner or parent excluding Asia and including that from a continued operation and that is continued operation increased 49% year-over-year, and decreased 93% quarter-over-quarter to RMB687 million.

The net profit margin excluding the effect of share based compensation cost was 49%, 4% and 500% of the three months ended September 30, 2020, September 30, 2019 and June 30, 2020, respectively. Our statement of financial position, we have cash in bank deposit of RMB15.3 billion as of September 30, 2020.

Net cash generated from the operating activity was RMB670 million, compared to the net cash generated from the operating activity of RMB88 million and RMB763 million for the third quarter of 2019 and the second quarter of 2020, respectively. Capital expenditure was RMB205 million, RMB480 million and RMB67.76 million [ph] for this quarter, the third quarter of 2019 and the second quarter 2020 respectively.

In the third quarter, we once again demonstrate a stable performance of course, all business division amidst a turbulent economic environment and complex international situation. As you can see, we are very, very resilient to those adverse situation.

We are competent that in our strategy, business model, operations resilience and our prospect going forward. We will further strengthen our research and development capability, improve the operation efficiency and promote product and service innovation.

We strive to provide our customer with the excellent service experience so as to achieve a sustainable growth in our business and create fruitful returns for shareholders and business partners. This concludes my introduction for the Q1 results.

I'll now hand back the call to question-and-answer. Thank you, Francis.

Hi, operator. We're ready for the Q&A session.

[Foreign language] Okay, I'll translate for Ms. Chao.

Thank you for taking my question. I have two questions here.

The first one is about the gaming business. We noticed that the -- can the management share what's the main reason for the QoQ decline of gaming revenue?

And how should we expect Q4 and next year's gain growth? And my second question is about Kingsoft Cloud and WPS.

So, can management elaborate the collaboration between KG [ph] and WPS in the coming quarters? Thank you.

[Foreign language] Okay, I'll translate for Mr. ZOU.

Regarding the question on the slight decline in revenue for quarter-on-quarter for the game business, there are mainly two reasons for it. The first one is that, like I said in the past, there is a seasonality in the pattern for the PC game JX Online III.

So usually, for the four quarters of the year, the revenue for the fourth quarter is greater than the revenue from the first quarter and then greater than the revenue from the second quarter, lastly will be the third quarter. So this is our pattern in the past and for this year, data from the Double Eleven [ph], Double Twelve [ph] event, we think that the same pattern will repeat in 2020 as well.

And also another reason for the Q-on-Q decline is that the new game that we launched, the JX Online II mobile game [Foreign Language]? The revenue result is actually less than our expectation, and that's due to various reasons; reasons on our own side and also our reasons for a partner and also the market impact.

The game that you just mentioned is a very successful game just launched, but it's a completely different game than our JX series. So currently, we don't think there's any competition relationship between that game and also our own game.

So for the fourth quarter and also the next year outlook. We need to mention that some of the games that we originally planned to launch in the fourth quarter will be delayed to the first quarter of 2021.

That includes JX World III, FFPE II and also Wo Long Yin. The delay may be due to various reasons.

For example, the FFPE II may take longer time to get the license approval as is IP from overseas from Japan; so it may take longer than expected time to get the license approval. So for the 2021, I'll look for the game business.

We do have new products, both for PC and mobile games. I mentioned the past that JX III had a very great performance this year, and there are also new development for the game next year as well.

Also some of the other new plans for 2021, we're not ready to disclose yet but there will be more products for both PC and mobile games. I think it will be better for us to have a more accurate forecast for next year.

Later to the end of this year, we have already started to do the budgeting for N-X [ph] for next year, starting in mid-November, it will be better for us to wait until the end of this year or early next year to disclose a more accurate plan for 2021. And the second question on the WPS and Cloud collaboration; I want to make it clear that the synergy and the collaboration I mentioned between these two businesses is not short-term, it's not something that have a short-term impact on one quarter or two quarters, it's more a long-term plan that we think there is a lot of collaboration and synergy opportunities between the WPS and Cloud businesses.

This year these two businesses are actually quite busy on their own; for example, the WPS since the start of the pandemic early this year, they have a lot of development in the -- in their products including online collaboration. For example, Kingsoft Doc product have a very significant increase during the pandemic.

And also for Kingsoft Cloud, it's just listed in the second quarter this year, it is also developing quickly in the current verticals. So this year these two businesses, they both have a lot of opportunities on their own.

And in the long-term we think that these two businesses will have a lot of collaboration and synergy opportunities in both, the 2B and 3G [ph] segments, in both the products and also the distribution of businesses. Thank you.

Hi, operator, we're ready for the next question. Thank you, Li Cheng [ph].

[Foreign Language] Thanks management for taking my questions. My first question about our use of cash.

Can management comments about our M&A strategies, as well as how we can return more value to shareholders like dividends? And my second question is about the OPEC strength.

Can management comments about the margin outlook for gaming, as well as the WPS? Thank you.

[Foreign Language] I'll translate for Francis. For the first question on use of cash; so in the past, we have make a plan that we'll use most of our cash in our business strategy related areas, no core opportunities.

So others -- other than the M&A uptrend that will most likely to take a conservative approach on our cash management. So during the pandemic period, we have a lot of opportunities in the high tech development for domestic players, and so there is a lot of opportunities for -- for example, for the Kingsoft Project for Kingsoft office.

And we think that this is still the area that we will make our M&A strategies, and also our R&D development team; so we'll still have most of our cash in the -- in this area. So as a part, we'll prioritize our cash -- use of cash spend.

So firstly, we'll use most of our cash on the related areas; core business strategy, in either M&A opportunities or R&D development. If we have -- still have more cash left over from the M&A or the R&D development, we'll also use our cash into optimize our dividend policy or share the purchase plan to better -- have -- to better return our shareholders.

So even -- and today, our board -- we have discussed this in our normal board meeting, and then we disclosed our dividend policy, our share -- repurchase plan once we have more confirmed detail. And also, we do have a big 5 to 10-year plan; so once we're ready, we'll also disclose that to the market as well.

And also we have another development -- R&D development center in Wuhan, so that's also where we're going to invest in the R&D development. So for the WPS and also the game margin performance; WPS is already an independent listed company, so you can also approach them directly, we're not going to disclose more details than what they already disclosed to the market.

But from more -- a high level view on this question, I'm going to discuss it in short-term, also in the mid to long-term for the WPS margin development. In the short-term from the past previous years, especially from 2013 to 2018, we were focusing the development of the mobile internet transformation for WPS business; so our operating profit margin was near breakeven level during the past years.

Once we started to monetize this business, our margin immediately increased to over 20% in 2019-2020, and we think that it's going to maintain this healthy level going forward as well. There are still a lot of opportunities in this new trend, also the online collaboration opportunities; so we are still going to keep investing in 2019-2020; the number of our R&D headcounts actually doubled.

But even with that, we are still going to have a high-single-digit percentage points improvement for the WPS margin this year, and so we think that for the upcoming three [ph] years, it's going to maintain a very healthy momentum. And for the long term, we think that there is a lot of opportunity for the WPS business.

We have been developed many, many years in the software licensing business, so as we increase the number of licenses we sell, we are going to increase our margin performance. Like I said, there are a number of R&D headcounts doubled in 2019-2020, but it's not going to double every year; so once the number of licenses increase, going forward that will increase our margin performance for WPS significantly.

Also, in the past, we -- this year we demonstrated a very healthy performance for our MAU and also DAU data for our top products in March and April; during the pandemic period, some of our products reached -- their MAU and DAU increased significantly. For example, the Kingsoft Doc increased MAU from 16 million to over 200 million in one quarter.

In June and July there is a slight decline in some of the products MAU and DAU. But now, in September and October we noticed that a lot of the MAU and DAU of a product actually reached to their peak level, it's even higher than what we had back in April or May.

So we think that we do have a very strong product line, and the performance of these products are very healthy and stable. And we think that there is also a lot of opportunities in this Kingsoft project, especially with the U.S.

China attention. So we think that the overall picture -- the overall opportunity is massive, we can mention that for the -- for one of our KPIs for this Kingsoft project where we have given to the market is that we want to get 90% of the total Kingsoft project in the market, and based on the performance from the previous nine months, our market share is actually 93% to 94%; so it's actually even better than our expectation.

So we think the long-term margin for WPS actually has a lot free opportunity. For the gaming business, we -- we do have a new plan for JX Online III PC game for 2021.

For the detailed updates, our new plan is not ready to disclose but we think that if the new plans for this game turned out well, there is actually a lot of opportunities for this PC game as well. And for this year, the JX Online III PC game is going to reach it's historical high in terms of it's gross [ph] billing, it's even higher than what we had in 2017.

This game itself has a very good margin -- high margin, so that also helped with the total gaming margin performance as well. And there is also sales mix change in the game business, we also have a business on the game distribution but that is still in the early stage.

But if that game -- the revenue from the game distribution increased in the future, this may actually dilute or gain margin for obvious reasons. Yes, so this is our -- the -- for the game margin.

Hi operator, we're ready for one last question. Thank you.

[Foreign Language] Thank you management for taking my question. And my first question is about the JX III operating situations after the October expansion pack launch.

And as we are also having another one in December, just want to understand a little bit more into the Q-on-Q trending to 4Q this year. Can we expect similar kind of Q-on-Q growth versus last year?

And second, a follow-up to that. If the deferred revenue we're looking at -- almost like four times more deferred revenue for the quarter versus last year.

Just want to understand a bit more breaking down into the gaming and WPS, what's the color over there? The last question is about operating expenses.

In terms of the R&D expenses on the non-gaming -- sorry, non-WPS side; I recognized that we do have some social and medical insurance premium impact, but other than that are we also investing into more of the game development? And in which area, if so?

Thank you so much.

[Foreign Language] I will translate for Francis. So for the fourth quarter outlook on the game business; actually we launched our last extension of the year in October 2020, and the result has been quite impressive.

The number of IP accounts actually increased after we launched the new extension pack, roughly about 30%; so the result -- the extension pack is actually quite good. For the fourth quarter of the game performance; first, I would like to say that the JX Online III PC game is going to reach it's historical high in terms of the total revenue, full year revenue.

The full year revenue will be greater than what we had in 2017, so this will be the historical high for the JX Online III PC game. For the fourth quarter, our game team actually is going to more to stabilize it's performance, we're now going to purely focus on the -- on pursuing the increase of our revenue performance, as we already did quite good in the first three quarters of this year.

And also for the fourth quarter, there -- some of the games that were originally planned to be launched in the fourth quarter will be delayed to 2021. For example, FFPE [ph], that will be -- reflection [ph] time will be dependent on it's license approval process.

And for [indiscernible], these two games are likely to be launched in the first quarter of 2021. And also for the R&D expenses increase; we think that the social insurance plan impact will decline.

I'll confirm with you on the details later. The gross margin, also the OP margin of our game business actually performed very well in the past but we still have many game studios in-house and they are developing new games.

And we also extend all of the developing expenses before the games are launched, so that's why, like I mentioned in the past; once we have new mobile games launched, our margin actually increased significantly because a lot of the R&D expenses are already expensed in the past. Thank you.

Hi, operator. This will conclude our presentation today.

Thank you.