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Hello, ladies and gentlemen. Welcome to First Quarter 2020 Kingsoft Corporation Earnings Conference Call. [Operator Instructions] Today's conference call is being recorded. I would now like to turn the conference over to your first speaker today, Ms. Francie Lu. Thank you. Please go ahead, ma'am.
Thank you. Ladies and gentlemen, good evening, and good morning. I would like to welcome everyone to our 2020 first 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 public-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 Executive 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 Tao. [Foreign Language]
Excuse me, the line of Mr. Zou Tao has disconnected. I think he's having a technical issue right now.
Yes, he's dialing again. [Technical Difficulty]
Speaker -- the line of speaker Zou Tao has now joined. Please go ahead, sir.
[Foreign Language]
[Foreign Language]
Okay. I'll translate for Mr. Zou Tao. [Interpreted] Our first quarter results represent a strong start of the year. The team did an excellent job in responding to the challenges of COVID-19 while delivering stable business progress. More importantly, the COVID-19 pandemic has expedited the digital transformation and online collaboration of all industries and, therefore, laid a solid foundation for our future development. Especially, we saw significant growth in the operational performance of cloud office products and services as WPS has been more widely adopted for remote working. Our flagship JX Online III PC game also achieved a stable performance with revenue continued to grow year-on-year. On May 8, 2020, Kingsoft Cloud was successfully listed on the NASDAQ. Our cloud services business continued to maintain its robust growth in the first quarter. And as the largest shareholder of Kingsoft Cloud, we have full confidence in its future performance. Riding on the wave of the post-pandemic digital transformation, we are marching towards a bright future and are determined to become a winner of this unprecedented new digital era. In the first quarter, our total revenue was RMB 1,171 million, up 32% year-on-year, kicking off 2020 on a positive note in spite of the COVID-19 outbreak. Our office software services and others and online game businesses grew 36% and 30% year-on-year, respectively, in the first quarter. Now we're turning the call to our CFO.
Thank you, Francie. Hello, everyone. For the first quarter of 2020, the business of Kingsoft Office Software and its subsidiary, collectively known as Kingsoft Office, developed steadily. Global monthly active user of WPS family reached record highs with strong growth of cloud office products and services, particularly WPS Doc. WPS Doc is an online document product, has become one of the largest online collaboration tools in China. Kingsoft Office has further consolidated its leading position in the office market in China. We have a dominant user base in WPS Office and WPS Docs. During the quarter, Kingsoft Office provided more than 4 million free business collaborative cloud office accounts to various government organization, enterprise, schools and medical institution to support the remote working and work resumption in fight against COVID-19. More than 100 government organization and industry association have adopted WPS+, WPS business one-stop cloud office service platform, as their preferred remote office product. With continued innovation and leading position in the field of office software, Beijing Kingsoft Office Software, Inc. was named as the Innovation Pioneer Enterprise in the Information Technology Application, and it was also admitted to the Information Technology Park in Jingkai District, a National Cybersecurity Industrial Park. WPS Office 2019 Security Edition received the prestigious Butian Award from the Independent Innovation Report of Internet Information in 2019 and Outstanding Product and Technology Award of Information Technology Application in China in recognition of its product excellence. The above breakthrough provide a solid foundation for our license business to seize opportunity in the areas of cloud service, innovative information technology and infrastructure investment. Going forward, Kingsoft Office will further leverage its technology capability to maintain dominant position and stellar reputation in document and information processing while enhancing user experience and offering easy-to-use yet highly effective products and services. In the first quarter, the online game business maintained a robust year-on-year revenue and user growth, reflecting our R&D track record in developing compelling online game and IPs. Revenue and average daily active user of our flagship JX Online III PC game recorded a year-on-year growth of 33% and 20%, respectively. While revenue from other PC game of the JX series increased by 44% year-on-year. For the mobile game business, our key mobile game JX Online I and Eudemons Online continued to perform steadily during the quarter. During COVID-19 outbreak, we have launched several charity initiatives, such as setting up an in-game fundraising and offering free game log-in in response to China's call to support epidemic prevention and control. We aim to deliver positive message in this unprecedented time and further enhance the positive influence of our IPs. On May 20 -- 22, 2020, we launched Jie Lu Zai Jiang Hu, a new expansion pack for JX Online III PC game, aiming to provide gamer with a new game experience. Going forward, we will continue to focus on quality content creation and further enhance the integration of R&D and operation, thus, laying a solid foundation for our online long-term development. I will now discuss the Q1 operational and financial results using RMB as currency. Before I start, I'd like to explain that the comparative figure are restated to reflect the reclassification between continuing operation and the discontinued operation. The operating result of Kingsoft Cloud has been presented as a discontinued operation. Revenue increased 32% year-on-year -- year-over-year and decreased 21% quarter-over-quarter to RMB 1,171 million. The revenue split was 67% for our online games and 33% for office software and others. Revenue from our online game business increased 30% year-over-year and decreased 15% quarter-over-quarter to RMB 781 million. The year-over-year increase was mainly due to the healthy growth of our flagship JX Online III driven by enhanced user engagement and monetization ability as well as enriched mobile game portfolio. The quarter-over-quarter decrease was largely due to the declined revenue from JX Online III as a large-scale expansion pack being successfully launched in the fourth quarter of 2019. Revenue from the office software and services and others increased 36% year-over-year and decreased 31% quarter-over-quarter to CNY 391 million. The year-over-year increase was mainly attributable to the revenue growth from WPS Office subscription services driven by rapid expansion of user base with enhanced features and services. The quarter-over-quarter decrease was largely due to the declined revenue from WPS Office licensing and WPS Office online marketing services resulting from a weak seasonality, which was partially offset by a solid and sustainable growth from WPS Office subscription services. Cost of revenue increased 15% year-over-year and decreased 14% quarter-over-quarter to CNY 201 million. The year-over-year increase and quarter-over-quarter decrease mainly reflected the changes in content and channel costs associated with revenue from licensed mobile games in each corresponding quarter. Gross profit increased 36% year-over-year and decreased 22% quarter-over-quarter to CNY 970 million. The group's gross profit margin increased by 3 percentage points year-over-year and decreased by 1 percentage point quarter-over-quarter to 83%. The increase in the group's gross profit margin year-over-year was mainly due to the increased revenue contribution from self-developed games, which have relatively higher gross profit margin. Our net research and development costs decreased 4% year-over-year and 13% quarter-over-quarter to CNY 355 million. The year-over-year decrease was largely due to the reduced outsourcing activity for our R&D projects as a consequence of the pandemic. The quarter-over-quarter decrease was mainly attributable to the temporary exemption or reduction of social and medical insurance premiums in this quarter. Selling and distribution expense increased 37% year-over-year and decreased 36% quarter-over-quarter to CNY 147 million. The year-over-year increase was mainly due to higher expenses incurred as WPS business continued to increase its sales and marketing efforts to expand enterprise market. The quarter-over-quarter decrease was mainly due to fewer promotion activities. Administrative expenses increased 17% year-over-year and decreased 28% quarter-over-quarter to CNY 93 million. The year-over-year increase was primarily due to the increased staff-related costs and professional services fee. The quarter-over-quarter decrease was mainly due to the reduced professional service fee. Share-based compensation costs decreased 21% year-over-year and quarter-over-quarter to CNY 31 million. Operating profit before share-based compensation costs increased 97% year-over-year and decreased 24% quarter-over-quarter to CNY 416 million as a result of the combination of the above reasons. The operating profit margin before share-based compensation costs increased by 12 percentage points year-over-year and decreased by 1 percentage point quarter-over-quarter to 36%. Net other gain of CNY 3 million were recorded as compared to the net loss of CNY 1 million for the first quarter 2019 and the net other gain of CNY 48 million for the fourth quarter 2019. The net other gain in the fourth quarter 2019 were mainly due to a gain on the deemed disposal of partial interest in a subsidiary. Share of losses of associates of CNY 64 million were recorded compared to a share of losses of CNY 78 million for the first quarter 2019 and a share of losses of CNY 402 million for the fourth quarter of 2019. Losses were mainly due to losses recognized in Cheetah Mobile in this quarter. Income tax expense increased 48% year-over-year and decreased 18% to CNY 64 million. Losses for the periods for discontinued operation reflected losses from Kingsoft Cloud, which was loss of CNY 481 million as compared to a loss of CNY 296 million in the first quarter 2019 and a loss of CNY 333 million in the fourth quarter 2019. The increased losses in absolute amount were in line with Kingsoft Cloud's revenue growth and business expansion. As a result, the profit attributable to the owners of parent was CNY 6 million as compared to a loss of CNY 68 million for the first quarter 2019 and a loss of CNY 100 million for the fourth quarter of 2019. Profit attributable to the owners of parent, excluding ESOP, was CNY 55 million compared to a loss of CNY 33 million for the first quarter of 2019 and a loss of CNY 56 million for the fourth quarter of 2019. And on our statement of financial position, we have a cash and bank deposit of around CNY 12 billion as at March 31, 2020. Net cash from operating activities was CNY 545 million compared to a net cash used in operating activity of CNY 50 million and from operating activity of CNY 493 million for the 3 months ended March 31, 2019, and December 31, 2019, respectively. Capital expenditure was CNY 328 million, CNY 279 million and CNY 341 million for the 3 months ended March 31, 2020, March 31, 2019, and December 31, 2019, respectively. We are pleased to achieve a satisfactory performance in the first quarter amidst the COVID-19 outbreak. Our business has strong resilience, and we are confident in the strength of our business model and our development going forward. Looking ahead, we will continuously increase our investment in key areas, improving our product and service capability, innovate on our business model with our ultimate focus being the provision of high-quality product and services to our customers. This concludes my brief introduction. Now I hand over the floor for question-and-answer -- for questions.
Hi, operator, we're ready for the Q&A session.
[Operator Instructions] Your first question comes from the line of Thomas Chong of Jefferies.
Congratulations on a solid set of results. My question is about the business trend in the month of April and May. What do we observe about the gaming trends in PC and mobile after Q1? And also, how should we think about the trend in the second half given that there may be a shortening in the summer holidays? [Foreign Language] And my second question is about the full year guidance in gaming and WPS as well as the margin trend after the discontinue of the business.
[Foreign Language]
Okay. I'll translate for Francis. [Interpreted] So talking about our game performance in April and May, for our JX III PC game, have been performing very well. The first quarter, both revenue and the number of users have increased in the first quarter. And in the second quarter, we are very confident because we have also launched a new expansion pack, so we believe that the second quarter, and including second half of this year, the JX Online III PC game is going to perform very well. And talking about the second half outlook, we believe that the JX III PC game is going very strong. The trend is very good. And also, we have other mobile games to be launched in the second half. So we have the JX III mobile game, which we are planning to do the public relaunch in the second half of June. So both Seasun and Tencent are going to provide resources in promoting this game, and we are going to treat this game as a new game. So the level of resources we put in the promotion of this game will be quite high. And the JX II mobile game, we are testing the game right now. So the final launching time will be depending on the testing results. Currently, we are planning for August or September launch time for the JX II mobile game. And also, we have a couple of other games to be launched in the second half of this year. So overall, the outlook for this year should be better than last year. And -- but currently, we are not going to put too much expectation from the JX Online II and JX Online III game in our budget as the gross billing is not going to be -- we cannot predict the gross billing at this stage, but we believe that overall this year will be -- should be better than last year. Thank you.
[Foreign Language]
Okay. I'll translate for Francis. [Interpreted] So for the game margin performance expectation, because we just said that the JX Online III PC game is going to be very strong this year and the game itself has a very good margin level, so we are confident that the margin level for the overall game business should improve from last year 2019. And for the WPS business, WPS now is an independently listed business, so they are going to give their own guidance. But from our point of view is that we think that the WPS margin in 2020 should be similar to what we had in 2019 or slightly better than what we had in 2019. Because under the current COVID-19 outbreak, the -- all industries are promoting the remote working and online collaboration. So this will benefit our online businesses for WPS. But on the other hand, there are some negative impact on the off-line business, especially in our licensing business where the off-line contract signing will be affected due to the COVID-19 outbreak. But overall, we believe that the margin for WPS should be similar to what we had last year or slightly better. Thank you.
[Operator Instructions] Your next question comes from the line of Liping Zhao of CICC.
[Foreign Language] I have 3 questions. First, could you update us the development of WPS Office and cloud business as China is gradually recovering from COVID-19? So is the trend long term? Or it's just a short-term trend? My second question is related to the deferred revenue. We noticed that even the spend of Kingsoft Cloud, we still maintain a high level of deferred revenue. Can you provide a breakdown of that? How much is from the gaming? And how much is from WPS Office? And my third question is related to the OP margin of gaming. Can you tell us what's the OP margin level in the first quarter? And what's the expected margin level for the full year?
[Foreign Language]
Okay. I'll translate for Francis. [Interpreted] So talking about the COVID-19 impact on our business, we'll talk separately on WPS and cloud and on game business. For the game business, we think that the whole game industry is benefiting from the COVID-19 outbreak. The people are staying home longer time, so online entertainment should be benefited during this period. But we believe that when people start to go back to work, once the COVID-19 outbreak start to recover, the gaming business should go back to normal. So we believe that the impact on the game business may be limited to the COVID-19 period. But for Kingsoft, for the first half, well, we launched our expansion pack for JX Online III. We noticed that both the independent number of IPs and also the -- a lot of the old users came back to play the game. These users have increased our user base for the game, and these users may stay in the game and play the game even after the COVID-19 period. So there may be some long-term effect on the game business for us. But on the WPS and cloud business, we think that the impact is very large and is very different. It has an unprecedented change in the whole industry. We always talk about an example on WPS Docs. By the end of last year, 2019, the user base was only 16 million for WPS Docs. But by March 2020, the number of users is 4x more than what we had by the end of last year. So we believe that the change in this industry in remote working and online working is unprecedented. So it has -- it's going to be a long-term impact on the whole industry on users' acceptance and transfer to the idea of remote working, on online collaboration. So we think the digital transformation here in these industries is now going to go backwards after the COVID period. Thank you.
[Foreign Language]
I'll translate for Francis. [Interpreted] So for the deferred revenue breakdown, in total, we have about CNY 1 billion. The breakdown between WPS and game business is roughly about half and half, so there's about CNY 500 million each. WPS increased roughly about CNY 100 million, and the game business increased about CNY 60 million. And we think that this is a good signal for both the WPS and the game business as people are paying more to play the games and also people are paying more -- more people are paying for the WPS members and Doc membership. Thank you.
[Foreign Language]
Okay. I'll translate for Francis first. [Interpreted] So we're talking about the game business margin. We just said that for the PC game JX Online III, it's going to go very strong this year. And this game itself has a very good margin level. For the mobile games, we have a few mobile games to be launched in 2020. Although we don't classify -- we don't put too much expectation on these games gross billing in our budget, but we believe that, overall, this year, in 2020, the game margin should be higher than last year by high single-digit percentage points. Thank you.
The next question comes from the line of Elsie Cheng of Goldman Sachs.
[Foreign Language] I have 2 questions. One is to follow up on the games overseas and a strategy update on overseas gaming business and just clarify on the margin outlook, which was mentioned on the game section. Have we booked in the R&D and sales and marketing spend that could potentially grow with the mobile pipeline that we just mentioned? And second question is about our capital allocation with Cloud IPO. I mean we have actually ample cash in our balance sheet. Just would like to invite management to share a little bit more about the capital allocation strategy or investment focus into the next 2 to 3 years.
[Foreign Language]
Okay. I'll translate for Francis. [Interpreted] So talking about the game business in the overseas market, at this stage, we don't want to talk too much on this. We are still in the planning stage, but we actually have a team that's focused in the overseas opportunities. We already took some action in the overseas gaming business. But at this stage, we don't want to talk too much. We'll wait until we have -- we reached to a more mature stage or we have more mature products, and then we can share with the market. And for the game margin question, like I said earlier that we have -- we're expecting a high-single-digit improvement on the game OP margin level from last year. And yes, this has already included the mobile game R&D for JX Online III, JX Online II. For these games, they are not only developed this year. For example, the JX Online II mobile game, we have been developing this in the past 2 to 3 years, and our R&D investment has been expensed during the past years as well. So it has already reflected in our P&L. And for the last question on capital allocation. We are -- we do have a good cash level on hand right now or -- especially under the current COVID period and also under the current unstable geographic political situation and also under the U.S.-China tension. We think that having a good cash level will make our business more stronger and safer. And also, it will accelerate our digital transformation. We'll also look for digital transformation opportunities. And the direction will be around our current business, which include the overseas gaming business, include the online collaboration and the cloud office products. And thank you. [Hi, operator, this will conclude our presentation today].
Ladies and gentlemen -- go ahead, sir.
Sorry, I'll just say thank you.
All right. Ladies and gentlemen, that concludes our conference for today. Thank you for participating. You may now all disconnect.
[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]