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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Ladies and gentlemen, thank you for standing by, and welcome to the Q3 2018 Kingsoft Corporation Earnings Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today, 12th of November 2018.
I would now like to hand the conference over to your speaker today, Ms. Francie Lu. Thank you, please go ahead.
Thank you. Ladies and gentlemen, good evening and good morning. I would like to welcome everyone to our 2018 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 join us today: Mr. Zou Tao, our Executive Director and CEO; and 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]
I will do the translation for Mr. Zou. We realized a steady growth in the quarter with Kingsoft Cloud and WPS Office enjoying a good performance. Due to the unfavorable environment of China's mobile game market at present, the performance of our existing games has been under pressure this year. Our revenue was RMB 1,537.7 million in the third quarter, up 18% year-on-year and 14% quarter-on-quarter, showing the stable financial performance of the company. In the third quarter, the Kingsoft Cloud and office software and services and other businesses continue to deliver healthy growth, up 68% and 29% year-on-year, respectively. Now I will turn the call to our CFO, Mr. Francis Ng.
Thank you, Francie and Mr. Zou. Hello, everybody -- sorry. Our flagship PC game, JX Online III; and our major mobile game, JX Online I, both achieved a stable performance during the third quarter. The JX World II mobile game released on the iOS platform in July enriched our product portfolio, and we also made good progress in the brand development. The new expansion pack released in July for JX Online I mobile game continue to attract players' attention and capture vitality of the game. On August 28, we celebrate the ninth anniversary of the JX Online III at the National Aquatics Center in Beijing, attracting a record number of viewers. The new comedy animation, JX Online III: Chivalrous Shen Jianxin, was a popular release. In September, JX Online III presented the designs and exquisite details of its costume at Paris Fashion Week 2018, which showcased the beauty of contemporary Chinese style to the world.
Our first theatric play, JX Online III: Live Fantasy, was staged in Chengdu in October. On 7th of November, the Legend of Sword and Fairy 4 was officially released. The game is expected to further diversify our mobile game portfolio and bring new experiences to players. We are also planning to launch JX Online II mobile game in spring 2019.
In addition to growing business of all cloud services among key video cloud clients, Kingsoft Cloud provide enterprise clients with comprehensive cloud-based industry solutions by integrating innovative technology such as big data, artificial intelligence, blockchain and IoT to meet their needs. Kingsoft Cloud has made progress in government, finance, health care, manufacturing and Internet of Vehicles sector. Kingsoft Cloud won the bid for the Beijing E-Government Cloud Phase III project and began to establish the Zaixiantong project, a one-stop government service platform.
Kingsoft Cloud also signed service contract for advanced cooperation with Huatai Security, Xiantao city and Angang and Great Wall Motor. In Xiantao city, Kingsoft Cloud smart house project was launched. Jinggang Cloud, the industrial cloud platform jointly built by Angang and Kingsoft Cloud also went online. Kingsoft Cloud cooperated with the Great Wall Motor to advance the Internet of Vehicles project. Looking forward, Kingsoft Cloud will continue to expand its market share of the all-cloud services, extending its ecosystem to the enterprise-level market and support overseas expansion of its client. WPS Office maintained a steady year-on-year growth during the quarter, benefiting from the user-friendly features and high-quality content. The number of paid members increased rapidly, along with the membership value-added services. WPS Office won a number of bid to provide office software products and services to some key government department in this quarter. WPS Office provide a secure edition of WPS Drive to the Ministry of Justice, facilitating its use of all WPS Office products on the cloud. WPS Office also became the exclusive office software provider on the procurement platform of the State Administration of Taxation.
We continue to invest in R&D in the third quarter, advancing the practical applications of AI. The smart writing robot program of WPS Office was among the first batch of national AI innovation projects. With persistent effort to drive innovation in its technology and rich professional experience of the industry, WPS Office chaired the Smart Writing Industry Alliance in China. In the future, we will increasingly apply AI technology in our products and services and add more AI-based solution in our portfolio. I will now discuss some Q3 operational and financial results using RMB as a currency. Revenue increased 18% year-over-year and 14% quarter-over-quarter to RMB 1,538 million. The revenue split was 44% for our online games, 39% for cloud services and 17% for office software and others. Revenues from our online game business decreased 9% year-over-year and increased 17% quarter-over-quarter to RMB 678 million. The year-over-year decreases are -- primarily reflected a decrease in revenue from the existing game, which was partially offset by revenue contributions from the newly released mobile games. And the quarter-over-quarter increase was mainly due to the revenue contribution of JX World II mobile games, which was launched on the iOS platform in July 2018, reflecting our continuous effort on diversifying and expanding mobile game portfolio with introducing high-quality mobile games.
Daily average PCU decreased 16% year-over-year and 9% quarter-over-quarter to 700,000. APA for the group online game for the third quarter 2018 decreased 16% year-over-year and increased 5% quarter-over-quarter to 3.4 million. The year-over-year decreases in the average daily PCU and APA was largely due to the natural declined life cycle of the existing games, which were partially offset by the release of the new mobile games. Revenue from the cloud services increased 68% year-over-year and 29% quarter-over-quarter to RMB 603 million. The healthy increases were mainly driven by a solid increase of our customer user -- usage from the mobile video and Internet sector, which demonstrated that Kingsoft Cloud has been sticking to fulfill the consumer needs and integrate innovative technologies, thus, further solidify competitive advantage in particular industry by providing the advanced products and reliable service.
Revenues from the office software and services and others increased 29% year-over-year and decreased 13% quarter-over-quarter to RMB 256 million. The year-over-year increase was mainly due to a rapid growth of the value-added services of WPS Office Personal Edition, which reflected the increased user engagement and stickiness with more practical functions and premium content provided. The quarter-over-quarter decreases were primarily due to the seasonality of the sales of WPS Office Enterprise Edition and online marketing service of WPS Office Personal Edition. Cost of revenue increased 51% year-over-year and 25% quarter-over-quarter to RMB 843 million. The increases were primarily due to a higher bandwidth cost and IDC costs, resulting from the increased customer usage of the cloud services. Gross profit decreased 7% year-over-year and increased 3% quarter-over-quarter to RMB 695 million. The GDP margin decreased 12 percentage points year-over-year and 5 percentage points quarter-over-quarter to 45%. The decreases of the gross profit margins were largely due to our change in sales mix. Our net research and development costs increased 45% year-over-year and 19% quarter-over-quarter to RMB 515 million. The increases were mainly due to the enhanced R&D investment as we engage in enhancing user experience and enriching products and functions.
Selling and distribution expenses increased 48% year-over-year and 45% quarter-over-quarter to RMB 228 million. The increases were primarily due to the increased advertising and promotional spending on online games.
Administrative expenses increased 82% year-over-year and 8% quarter-over-quarter to RMB 115 million. The year-over-year increase was mainly due to increased staff-related costs and professional service fee. We have had several sale of property put to use in early 2018. Share-based compensation costs decreased 32% year-over-year and 2% quarter-over-quarter to RMB 51 million. Operating losses before share-based compensation costs was RMB 133 (sic) [ RMB 134.2 ] million compared to an operating profit before share-based compensation costs of RMB 225 million for the third quarter 2017 and RMB 65 million for the second quarter of 2018.
Net other losses were RMB 83 million compared to gain of RMB 5 million in the corresponding period last year and losses of RMB 74 million in the second quarter 2018. The losses in the third quarter and second quarter of 2018 were mainly due to the recognition of foreign exchange loss in corresponding quarter.
Income tax expenses decreased 36% year-over-year and 49% quarter-over-quarter to RMB 29 million.
As a result of the reason discussed above, loss attributable to owners of parent was RMB 59 million compared to a profit attributable to owners of the parent, including that from continued operation and discontinued operation, of RMB 238 million for the third quarter 2017 and RMB 101 million for the second quarter 2018.
Loss to owners of parent excluding ESOP was RMB 22 million compared to profit attributable to with the owner of parent exclusive of ESOP, including that from continuing operation and the discontinued operation, of RMB 307 million for the third quarter of 2017 and RMB 139 million for the second quarter of 2018.
Our statement of financial position. We have cash and bank deposit of RMB 9.9 billion at 30th September 2018. Net cash generated from operating activity, including that from the continued operation and the discontinued operation, was RMB 6 million, RMB 624 million and RMB 265 million for the 3 months ended September 30, 2018 and September 30, 2017 and June 30, 2018, respectively. Capital expenditure, including that from continued operation and the discontinued operation, was RMB 532 million, RMB 177 million and RMB 254 million for the 3 months ended September 30, 2018, September 30, 2017 and June 30, 2018, respectively. Our operation remains generally stable with good momentum from growth in the third quarter. There were some unfavorable factors. Our overall profitability may be a bit of -- under a bit of pressure during the remainder of the year. Looking ahead, while continuing to push forward with steady operation, we will focus on bringing the advantage of our integrated cloud services and our office software and services business into play. With the debut of our flagship mobile games next year, the continuing growth and development of Kingsoft Cloud and WPS Office, we believe the overall performance will improve.
Thank you.
Operator, we're now ready for the Q&A session. Thank you.
[Operator Instructions] The first question comes from the line of Thomas Chong from Crédit Suisse.
I have a couple of questions regarding different business segments. First, on Kingsoft Cloud, we see the momentum is very strong. I just want to get a sense about how we should think about the competitive landscape in 2019, and also, when we should expect traditional sectors to start contributing revenue. And my second question is about WPS. Can management give us some breakdown about 2C and the 2B revenue in Q3 as well as the 2019 outlook? And finally, regarding the online games revenue, is there any updates about the time line for the launch for mobile JX III?
Thomas, do you want to ask the question in Mandarin as well?
[Foreign Language]
[Foreign Language]
So I'll do the translation for Francis. So regarding the competition landscape for the cloud business in 2019, currently, we maintain a very healthy revenue growth momentum for the cloud business, and we believe that this momentum will continue into 2019. And for the overall public cloud services, this has become more and more popular, especially in the Internet-related segment, for example, the video cloud. The growth for video cloud is still very strong. So we believe that in 2019 the growth for the cloud business will continue. Thank you.
[Foreign Language]
So I'll translate for Francis. So regarding the revenue split between the 2B and 2C segments in WPS, we already mentioned last time that the nonlicensed sales revenue growth is faster than the licensed sales growth. So the nonlicensed sales growth include the VIP number services, include the value-added services, which is growing faster than the other segments, including the government and the enterprise services. So the trend is sustained in this quarter so that 2C revenue is greater than the 2B revenue contribution. And the 2C revenue includes other value-added services, but they also include the mid- to small enterprise services that we provided. But right now, we generally split our revenue for WPS into licensed sales and value-added services. So if we count all the value-added services as 2C revenue, then the 2C revenue is definitely greater than the 2B revenue. Thank you.
[Foreign Language]
So for the current ratio between the 2C and 2B revenue for WPS, the 2C revenue is much higher than the 2B revenue contribution, almost double the 2B revenue. So about 1/3 of the revenue for WPS is from the 2B business, and 2/3 of the revenue from WPS is from the 2C revenue. Thank you.
The next question comes from the line of Liping Zhao from CICC.
[Foreign Language] I have 2 questions here. The first one is related to the gaming sector. So how is the Legend of Sword and Fairy 4 performance in the past week? And what's our projected gross billing? And I have a general question on the gaming industry as well, because recently, the game launched seldom has any like flagship games, whether this will impact our pipeline in the future. And my second question is related to WPS growth. So last quarter, the WPS growth is around 70% year-over-year, but this quarter, has slowed down to around 30%. So what's the reason behind it? And what's the current time line for WPS IPO?
[Foreign Language]
Okay, I'll translate for Mr. Zou. So for the Legend of Sword and Fairy 4 game that we launched on November 7, based on the current data, the game has well met our expectations. But regarding the detail of gross billing and also the revenue-sharing arrangement, this information, we have not disclosed them yet. And also, for the other question, that in 2018 there are less flagship games launched in 2018, whether this will affect our launch for the other mobile game. So this year, we have been delayed a couple of times for our mobile games, but right now we are still strictly sticking to our plan and we are still adjusting and testing the mobile game together with Tencent. So this does not have much impact on our own pace.
[Foreign Language]
I'll translate for Francis. So the revenue for WPS slowed down a bit in the third quarter. This is due to both the seasonality factors and also our intentional control on our monetization in the advertising revenue, and also, one of a big contract sales that we need to confirm and book later into the fourth quarter. But overall, for 2018, we will definitely meet our previous guidance on the WPS revenue growth. Regarding to the IPO plan, right now we are still in the Q, so we don't have much comment on the details, but we just sent in the mid-year 2018 financial results, but we're still in the Q. Thank you.
The next question comes from the line of Alex Liu from China Renaissance.
[Foreign Language] I'll translate myself. So we noticed there has been a delay for the JX II mobile. So I'm just wondering what's the -- after the repolishing of the products, what's the sort of the target audience for JX II mobile versus the potential launch of the JX III mobile and whether the delay may imply that we actually have a higher grossing target for this title and whether this delay will be -- meaning that the JX II will be happening perhaps later than JX III. And finally, question is on whether the management are thinking about doing some stock repurchase.
[Foreign Language]
So I'll translate for Mr. Zou. The JX Online II mobile game has been delayed for several times this year, and this is mainly due to 2 reasons. The first is because the overall game market in China has experienced a lot of changes this year, especially compared with the previous years in the RPG game market. So together with Tencent, we adjusted our launch time accordingly. And the second reason is that the government control in the game market is much stricter this year, and a lot of the games are unable to get the license. But we have the license for the JX II online mobile game, and so we want to take advantage of this license and then we want to polish the game to a better quality and better level. So due to both reasons, we have been delaying the launch of the JX Online II this year, and we apologize for that. And for the JX III -- JX Online III mobile game, regarding the order the launch for JX Online II and JX Online III mobile games, we'll definitely launch JX Online II mobile game before JX III, and no, this order will not be changed. Thank you.
[Foreign Language]
So I'll translate for Francis. For the buyback, it's a very good question there. We made a lot of discussion in the board meeting this afternoon, including the buyback plan. So we will be closely monitoring the market changes in the future, and we want to maintain a good strong cash level so that we have enough cash to invest in the cloud businesses in the future. But at the same time, we will closely monitor the market changes, and at the appropriate times, we will make the move closely with the market changes. Thank you.
The next question comes from the line of Hillman Chan from Citigroup.
[Foreign Language] I want to also follow up on the 2 games, mobile JX II and mobile JX III. I want to have more color on the latest round of beta testing in terms of the user retention and also the paying ratio as well as do we expect more rounds of beta testing before commercial launch of these 2 titles, and lastly, on the monetization models of them. And then on another title, Final Fantasy, could management share the timeline with us?
[Foreign Language]
[Foreign Language]
[Foreign Language]
I'll translate for Mr. Zou. So after several rounds of testing for JX Online II and JX Online III mobile games, so in some areas, both games have met our expectations, but in some other areas, we still need to further polish the games. So together with Tencent, we will continue testing for both games. So for the JX Online II mobile game, we'll have another -- at least another round of testing before the commercial launch, and for JX Online III mobile game, we will have another 1 to 2 more rounds of testing before the commercial launch. And for the monetization of JX Online II and JX Online III mobile game, so unlike the PC game, both games will be monetized based on the virtual items. And for the Final Fantasy, we got the license to distribute the game in China, but because of the government control on the game market, we haven't got the license approval for this game yet. So we don't have any comment on the time line for the game launch.
The next question comes from the line of Wendy Huang from Macquarie.
I just have 2 housekeeping questions. One is about JX III PC. I just wonder, what's the current schedule or thinking behind the launch of the JX III PC expansion pack? And generally, the sales and marketing costs increased in Q3 despite the fact of a light game launch. So what was the reason behind it? And also, how should we think about the sales and marketing costs in Q4 and 2019? [Foreign Language]
[Foreign Language]
[Foreign Language]
So I'll translate for Mr. Zou and Francis. So for JX III PC game, we do plan to launch new content, a new expansion pack. So we'll definitely work closely with the government to get the approval for -- and we are confident to launch the new content in the near future, in the near term. So for the JX Online III, we have been investing in the sales and marketing in this year. We are -- we have been -- keep expanding the brand influence of the JX IP. So we did a lot of things, for example, the -- on August 28, we have the anniversary event for JX Online III PC, and also, we also have the experts' competition. We launched the new comedy animation show and we also launched the theatrical play for the JX Online III. So we did all of these things to keep expanding the IP impact, the IP influence on the users. And so we'll continue going to invest in the brand development in 2019 as well, which includes the experts' competition, the comedy animation, also, theatrical play for the JX Online III PC game. And also, Francis added that in the third quarter, the spending and distribution costs increased because we hosted the eighth (sic) [ ninth ] anniversary event for JX Online III PC game, and in addition to that, we launched JX World II mobile game in the third quarter. For this game, we worked together with Xiaomi to co-distribute the game, so we also have to spend in the spending and distribution in distributing the JX World II mobile game. Thank you.
[Foreign Language]
[Foreign Language]
[Foreign Language] I was just wondering whether the one launch you recently -- actually had, whether JX III PC is just a one-off incident or we should expect a similar tightening for the future updates of the existing titles as well?
[Foreign Language]
Okay, I'll translate for Mr. Zou. So I would like to clarify that we have always been -- need to get the approval for the new content for launch of the expansion pack for both PC and mobile games. And this requirement is the same in the past, present and also in the future. So the approval requirement has not been changed for the expansion pack or the new content for both PC and mobile games. But what has changed in the recent term is that the government has halted the -- granting the license approval to new games. So in the future, whether the government will become stricter in approving the game content, that's the question that we have to consider. So for the JX PC game, we are confident that this game comply with the mainstream requirement in the China market, so it has less risk in not getting the approval for the game. What's more, once the government will become stricter to -- it might be more to the overseas imported games or to other more innovative categories of the games, but not JX III PC-type games. Thank you.
Operator, this will conclude our presentation today. Thank you.
Thank you, ladies and gentlemen. That concludes the conference today. Thank you for your participation. You may all disconnect your lines now. Thank you.