Kingsoft Corporation Limited (OTCPK:KSFTF) Q3 2023 Results Conference Call November 21, 2023 6:00 AM ET

Company Participants

Francie Lu - Investor Relations

Tao Zou - Executive Director and Chief Executive Officer

Yi Li - Acting Chief Financial Officer

Conference Call Participants

Xiaodan Zhang - CICC

Daley Li - Bank of America Securities

Linlin Yang - GF Securities

Operator

Good day, and thank you for standing by. Welcome to the Q3 2023 Kingsoft Corporation's Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your speaker today, IR Director, Francie Lu. Please go ahead.

Francie Lu

Thank you, operator. Ladies and gentlemen, good evening and good morning. I would like to welcome everyone to our 2023 third quarter results 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 join us today: Mr. Zou Tao, our Executive Director and CEO; and Ms. Li Yi, our acting CFO.

Now I'm turning the call to Mr. Zou.

Tao Zou

In the third quarter, our core businesses have made steady progress, focusing on the priority strategies of AI and collaboration. Kingsoft Office Group continuously optimized the AI performance of products. Online game business continued to iterate and upgrade self-developed premium games.

In the third quarter, the group maintained stable financial performance. The total revenue was RMB2,060 million, representing a year-on-year increase of 12%, mainly due to the steady growth of JX Online III and the sustainable growth in subscription businesses of both individuals and institutions from Kingsoft Office Group.

The operating profit was RMB376 million, representing a year-on-year increase of 13%. Now I will turn the call to Ms. Li Yi, our acting CFO.

Yi Li

Thank you, Francie. Good evening, everyone. In the third quarter, for individual office subscription business, Kingsoft Office Group optimized its membership system, improved user experience across its products and achieved steady increases in both the paying ratio and average revenue per paying user. To enhance the AI performance of our products, we invested in independent development of small and medium-sized models.

We have reached strategic cooperation with Alibaba Group and iFlytek to jointly build a digital and intelligent service ecosystem. Regarding institutional subscription business, we actively promoted cloud integration and collaborative office progress for government and enterprises and develop high-quality digital office solutions to assist them in their digital transformation.

Through WPS 365, we continued to facilitate customers' adoption of cloud and collaborative applications and made significant progress in expanding our user base in micro, small and medium-sized enterprises. In order to strengthen regional service construction, we organized a series of digital office activities in cities in China, such as Suzhou, Guangzhou and Harbin and continuously expanded our penetration in multiple industries, including energy, education and finance.

In the third quarter, JX3 Online updated constantly and sustained good atmosphere in the player community. In August, JX3 Online celebrated the 14th anniversary with players. In October, it launched the beta test with ultimate graphic quality and a new expansion pack, ensuring the ongoing success of the IP. World of Sword Origin was released in China in September and received recognition from players.

This mobile game was transformed from PC games through optimizing and upgrading the traffic and gameplay details while retaining traditional 2D graphics and classical gameplay. We also optimized the anime game Snowbreak: Containment Zone on an ongoing basis. Looking forward, the mobile version of JX3 Ultimate has received the license approval and is expected to be launched in the first half of next year to achieve accessibility through all platforms.

I will now discuss the Q3 operational and financial results using RMB as currency. Revenue increased 12% year-on-year and decreased 6% quarter-on-quarter to RMB2,060 million. The revenue split was 53% for office software and services and 47% for online games and others. Revenue from office software and services business increased 9% year-on-year and decreased 2% quarter-on-quarter to RMB1,098 million.

The year-on-year increase was mainly due to the growth of both domestic individual office subscription business and institutional subscription business of Kingsoft Office Group, partially offset by the decrease in revenue from domestic and institutional licensing business. The steady growth of domestic individual office subscription business was primarily driven by the upgraded membership system and better user experience.

The rapid growth of domestic institutional subscription business was mainly driven by continuous upgrade of digital office solutions and service quality, along with our ongoing efforts to promote cloud integration and collaborative office in government and enterprises. The decrease in domestic institutional licensing business was largely due to the reduction in new purchase orders on localization solutions.

The slight quarter-on-quarter decrease was mainly due to declined institutional licensing business, partially offset by the sustainable growth of institutional subscription business. Revenue from the online games and others business increased 15% year-on-year and decreased 10% quarter-on-quarter to RMB961 million. The year-on-year increase was mainly due to revenue growth from JX3 Online and revenue contribution from Snowbreak: Containment Zone launched in July, partially offset by decreased revenue from existing games.

The quarter-on-quarter decrease was primarily attributed to the decline in revenue from JX3 Online, which had a relatively high base in the second quarter. Cost of revenue increased 3% year-on-year and 6% quarter-on-quarter to RMB383 million. The increases were mainly due to the increased personnel-related expenses as well as higher server and bandwidth costs. Gross profit increased 14% year-on-year and decreased 8% quarter-on-quarter to RMB1,677 million.

Gross profit margin decreased by 1 percentage point year-on-year and decreased by 3 percentage points quarter-on-quarter to 81%.Research and development costs increased 5% year-on-year and 1% quarter-on-quarter to RMB672 million. Selling and distribution expenses increased 24% year-on-year and 47% quarter-on-quarter to RMB441 million. The increases were largely due to the marketing campaign for newly launched game.

Administrative expenses increased 20% year-on-year and 22% quarter-on-quarter to RMB187 million. The increases were mainly due to increased personnel-related expenses. Share-based compensation costs increased 15% year-on-year and decreased 20% quarter-on-quarter to RMB73 million. Operating profit before share-based compensation costs increased 14% year-on-year and decreased 41% quarter-on-quarter to RMB449 million.

Net other gains for the third quarter of 2023 were RMB18 million compared with losses of RMB6,487 million and RMB103 million for the third quarter of 2022 and the second quarter of 2023, respectively. The losses in the third quarter of 2022 primarily resulted from the provision for impairment on the investment in Kingsoft Cloud.

Share of losses of associates of RMB307 million were recorded for the third quarter of 2023 compared with losses of RMB414 million and RMB323 million for the third quarter of 2022 and the second quarter of 2023, respectively. Income tax expense for the third quarter of 2023 was RMB44 million compared with income tax credit of RMB589 million for third quarter of 2022 and income tax expenses of RMB78 million for the second quarter of 2023, respectively.

The income tax credit for the third quarter of 2022 was mainly attributable to the deferred tax effect of the impairment provision recognized for Kingsoft Cloud. As a result of the reasons discussed above, profit attributable to owners of the parent was RMB28 million for the third quarter of 2023 compared with loss of RMB6,055 million for the third quarter of 2022 and a profit of RMB57 million for the second quarter of 2023, respectively.

Profit attributable to owners of the parent, excluding share-based compensation costs was RMB69 million for the third quarter of 2023 compared with loss of RMB6,007 million for the third quarter of 2022 and profit of RMB123 million for the second quarter of 2023, respectively. The net profit or loss gain, excluding the share-based compensation costs were 3%, minus 327% and 6% for this quarter, the third quarter of 2022, and the second quarter of 2023, respectively.

The group had a strong cash position towards the end of the reporting period, as at 30 September 2023, the group had cash resources of RMB23 billion. Net cash used in operating activities was RMB552 million for this quarter, and net cash generated from operating activities was RMB288 million and RMB1,945 million for the third quarter of 2022 and the second quarter of 2023, respectively. Net cash flows used in operating activities in the third quarter of 2023 was mainly attributable to the payment of cash collected in the second quarter of 2023.

Excluding this impact, net cash flows generated from operating activities was RMB447 million. Capital expenditures were RMB160 million, RMB106 million and RMB104 million for this quarter, the second quarter of 2023 and the same quarter of 2023, respectively. In the third quarter, we committed to refining and optimize our core products and services.

Going forward, Kingsoft Office Group will continue to focus on AI and collaboration with restructured office software to provide users with intelligent product experience. Meanwhile, online games business will continue to develop premium games and maintain long-term operations to better serve players. We will remain our focus on investing in the research and development of our core business to enhance our core competencies and achieve high-quality and sustainable growth. Thank you.

With that, I'll hand over to Francie.

Francie Lu

Thanks, Ms. Li. And Sandra, we are ready for the Q&A session. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] We will now take the first question from the line of Xiaodan Zhang from CICC.

Xiaodan Zhang

First of all, the flagship JX Online III has delivered strong performance year-to-date with quarterly gross billings reached record high. As the upgrade version is planned to launch officially in next April, so what are the commercialization plans we can think of at this time, especially targeting your existing players? Also, could you please share your preliminary views on next year's gaming business outlook? And secondly, WPS AI has released its public beta recently. So what do you think of the subsequent commercialization plans?

Tao Zou

So for the first question regarding our game business, we have not changed our monetization model for the JX Online III since it's launched in 2009 and including the newly launched flagship -- our platform testing version and its upgrade. So we still maintain our strategy to provide a fair gameplay for our users -- our game players. And so our monetization model is unchanged. We will keep the point cards model plus the value-added services. We will continue to upgrade the game by providing better quality of the game to keep optimizing the game experience for our existing players.

But the monetization model will keep unchanged with the point cards and value-added services. A new thing that will happen next year is the JX3 Ultimate version. This one, we already got the license. So we are planning to release the game in the first half of next year. This mobile version of the JX3 game is connected with our PC version.

So we will have more users that will be able to enjoy the game. So we expect the total timing of the gameplay will increase next year. And we will have an improved and increased interaction stickiness for the game. So through our experience, we expect that the value-added services will also improve with the increase in the interaction stickiness. But we will eventually evaluate the improvement after the launch of the game next year.

And also for the next year outlook for the game business, other than the JX3 mobile version, we also have another game that will be launched next year under the JX series, but we are not ready to announce the exact name yet, but there will be a new game in the JX series.

And also, we have the new game Code Break, which will also be launched next year. The financial forecast for next year of the game business is still under review. We will have our first version ready not until the mid-December. So the financial forecast is still under review for the game business.

The second question is regarding the WPS business and also its commercialization schedule. We will start the monetization testing for the WPS AI products in December.

And a lot of people asked about the pricing strategy for the new products. We have communicated with the WPS team in the Board meeting today, but the pricing strategy is not confirmed yet. In my point of view, we will use the differentiated pricing strategy for the products, which we will start the testing in December, and we'll continue to optimize in the first quarter and second quarter next year. And we will gradually open out the functions for the products to our users, the AIGC is already released, and we will continue to open the other copy lock and insight functions to our users. And we will eventually set the pricing strategy through our testing in December and also our user feedback in the first quarter and second quarter next year.

Operator

We will now take the next question from the line of Daley Li from Bank of America Securities.

Daley Li

I got two questions. First question is regarding the gaming business. It seems this year, the gaming business is becoming more competitive, given more license for the games. Could you -- management, could you share more color about our new strategy for business growth of the gaming? And then question about the share repurchase.

Could you update us any targeted value amount for the share repurchase plan in the future?

Tao Zou

So just like you said, compared with the previous three years, it is a lot easier to get -- a lot more easier to get the licenses for the games. So this, we believe, is a positive news for the entire gaming business, even though the competition also increased as the number of licenses increased. But we -- in general, we welcome this change as we also benefit from this change. So we think that it is beneficial for the entire gaming business. We also have a number of new games that will be launched next year.

For example, the first one will be the JX III mobile version, which will be launched next year. This game is, like I said in the first question, is connected with the PC version. So this will be a core game strategy for next year. And also, we have another game in the JX series, which will be launched next year. And there will be a third game, it's a mechanic game, it's called Code Break.

It will be targeting to the global market. This game has been developed for many years, and we're also ready to launch this game next year. So these three games have relatively -- certainty to be launched next year. And we also have a number of other games, which are under development that will -- that I will not mention at this moment. And also for the long-term gaming strategy, we think that we will keep our strategy unchanged for relatively long term.

And the first one will be that we will continue to develop the JX series. And the second one is that we will continue to expand to other games and other game IPs, which we have been trying for the past few years, and we will keep -- certain to continue in this strategic direction. And thirdly, we are going to focus on the global strategy. This we have also made a few trials in the past, and we will continue to keep our strategy in the global market going forward.

So regarding the second question on stock repurchase, as you noticed that in the Board meeting, which took place in this May, this year, we have already got a budget of HKD1 billion for the purchase -- stock repurchase plan. And we have made a number of stock repurchase in the past when we believe that the stock price is at a relatively low point.

So before we get a new budget, we will continue with this budget and continue our repurchase on a daily basis if we believe that the stock price is at a relatively low point. And if we need a larger scale of stock repurchase or if we need an adjustment on the stock repurchase budget, we'll still need to have a new Board approval. So in the -- under normal circumstances, we'll continue to have our stock repurchase within this budget and within the HKD1 billion budget.

Operator

We will now take the next question from the line of Linlin Yang from GF Securities.

Linlin Yang

My first question is about on the game business, considering the strong performance of [JX Online], any outlook about game business in the fourth quarter this year? Next question is about WPS. WPS upgraded membership system in the first half year. How about the users' feedback? And when we'll see more positive impact on this business revenue?

And more question about -- one more question about the expense. We saw expense rate grow this quarter. So what's the reason for the growth? And how should we expect its change in the next year?

Tao Zou

So regarding the first question on the fourth quarter game forecast, we were expecting a strong performance from JX Online III. Through our past years' experience, the fourth quarter is usually the best quarter for JX game itself. So we think that the annual growth for JX III is still very strong, very good. But as you know, last year, we launched the game, JX World III, its performance actually exceeded our expectation last year. And this year due to its subscription model, actually have a natural decline.

And also the new game that we launched this year, [indiscernible], did not meet our expectations. So the increase in JX Online III and also the decrease in JX World III, this will offset each other. So the overall gaming is still increasing, but we still give a single-digit increase guidance for the -- annual guidance for the gaming business.

So regarding the question on the WPS membership system that we had upgraded in April and other than the AI strategy, the membership system upgrade is actually the second largest core strategy for the WPS -- for the Kingsoft Office business this year. We already said that -- in our previous quarter earnings call, that we had faced some challenges in the second quarter. But based on the data, based on the performance today, we believe that both the number of paying users improvement and also the improvement in ARPU have met our expectations currently.

Regarding the timing and its impact on the revenue and on the monetization model, we think that the key change here is actually the AI. From the Board meeting today, the Kingsoft Office CEO also reported that he thinks that the opportunity of the AI strategy will further improve the ARPU and also the number of paying users. So next year, we're going to keep continuing to focus on the AI strategy, and we want to catch the AI opportunity to keep improve the penetration of the paying users. And in turn, we will increase the number of paying users. So right now, we are not only looking at the membership system.

Instead, we are going to combine it with the AI opportunity. We want to capture the AI opportunity to have a breakthrough in the monetization model for the Kingsoft Office business. So we have said that we will improve the ARPU from the new membership upgrade, but this is based on the budget that we had from two years ago. But with the upcoming -- with the current AI opportunity, we think that the upcoming strategy will be focusing on both the AI and also the membership upgrade. So for the WPS business, we are going to continue with the three strategy that is, number one, we will increase the number of users, number two is that we're going to improve the penetration of the paying users, and number three is that we are going to improve the ARPU for the membership system.

Yi Li

So regarding the third question on our expenses, we noted that in this quarter, the expenses increase is mainly due to the marketing increase that we had a increase year-on-year with 7 percentage points and quarter-on-quarter, it was 2 percentage points. But we believe that this increase is only a short-term increase. So Q3 will be the quarter with the lowest expenses level. And on the fourth quarter, this level will come back to a reasonable level. So in terms of the annual expenses, we will keep our expenses at a reasonable and healthy level.

Operator

There are no further questions at this time. I would like to turn the conference back to Francie Lu for closing remarks.

A - Tao Zou

[Foreign Language]

A - Francie Lu

Thank you for joining us today, and this will conclude our presentation for the 2023 third quarter earnings call. Thank you.

Operator

This concludes today's conference call. Thank you for participating. You may now disconnect