China Literature Limited (772) Earnings Call Transcript & Summary

Good evening, ladies and gentlemen. Welcome to China Literature's 2020 Interim Results Conference Call. A copy of the interim results announcement can be found and downloaded from its Investor Relations website, http://ir.yuewen.com. [Operator Instructions] I would now like to hand the conference over to your host today, Ms. Maggie Zhou, Head of Capital Markets and Investor Relations in China Literature. Maggie, please go ahead.

Thank you, operator. Ladies and gentlemen, welcome to our 2020 First Half Results Conference Call. Joining us today on the call are our CEO, Mr. Edward Cheng; our President, Mr. Xiaonan Hou, and our Vice President of Finance, Ms. [ Vivian Wang. ] For today's call, Edward will discuss the company's strategies, Xiaonan will review the company's business, and [ Vivian ] will go through the financials. We will then open the call for questions. Before we begin, I would also like to remind you that management's comments during the call will include forward-looking statements that are based on our current expectations. All statements other than statements of historical fact during the conference call are forward-looking statements, which are subject to a number of risks and uncertainties and then may not be realized in the future for various reasons. Information about general market conditions is coming from a variety of sources outside of the company. The presentation also contains some unaudited non-IFRS financial measures that should be considered in addition to, but not as a substitute, for measures of the company's financial performance prepared in accordance with IFRS. So please, do take a minute to read the risk factors and non-IFRS measures discussion in China Literature's 2020 first half results earnings release. I will now turn the call over to our Chief Executive Officer, Edward.

Thank you, Maggie. Hello, everyone. Thank you for joining us during this earnings call today. And this is the first earning call I have ever hosted since joining China Literature April this year. And during this very first call, I regret to announce that during the first half of 2020, the company recorded a loss for the first time in many years. The result is not a total surprise. Immediately upon my appointment as CEO and together with the key members of the new management team conducted a deep dive analysis to understand the competitive landscape as well as the strength and weakness of the company, and we realized that the company is facing many challenges. Starting with the well-known pandemic, a dominating force that has drastically changed the world over the past few months. The business community was paralyzed for at least half of the year. Larger corporations are cutting expenses and many small and medium enterprises were forced to shut down on their operations. Off-line consumer demands shrunk dramatically, streets were almost empty and theater chains were locked and closed. While on the supply side, numerous projects, including TV and film productions were delayed. The release dates are still uncertain for many projects. The pandemic, together with the fluid and the changing macro environment, indeed have had a negative impact on our business performance. Yet, it is not a fundamental reason for our disappointing results. Looking deeper, we realized that the company has structural issues that have piled up in recent years. This have gradually degraded our market share and neutralized our competitive edge. For example, our core online reading business has been facing challenges. The robustness of the China Literature platform depends on our talented writers and their creative drive. In the past, we failed to take full care of our writer's feelings and support them adequately through our incentive program. And some of our writers expressed concerns about the previous version of the writers' contract. Writers are the cornerstone of the China Literature's platform, and we need to do more to enhance their trust. Meanwhile, the free-to-read business failed to meet our expectations. Last year, we launched our free reading app, Feidu, as a supplement to our paid reading products. The free-to-read reading products have strong influence in certain markets and over certain user groups. But Feidu's overall performance failed to reflect the leading position the company enjoys in China's online literature sector. Turning in to our IP business. Consolidation with New Classics Media, or NCM, failed to produce the full synergies. NCM is no doubt one of the best creative and production houses in China. After the NCM acquisition, we tried to systematically convert our leading IP into TV series and films. The results were encouraging as witnessed by the popularity of Joy of Life but far from an overall success. And our integration with NCM fell behind the schedule, largely because we lacked a team with sufficient knowledge of both online literature and the drama production to drive progress. At the same time, we lacked a structure of top-down design to create an IP-centric content and operational strategy, which could maximize the lifetime value of IP by promoting cross-media production. Our past efforts has resulted in some success stories, but the real issue is how to scale. We now know we need a detailed systematic set of guidelines to turn our valuable IP into comics, animation, TV series, films and games. We need to carefully manage the value of each IP over its lifecycle and apply a common methodology to the entire IP portfolio in order to maximize portfolio returns. Last but not least, we have many business partners that have not yet successfully been converted into participants in our ecosystem. With business models, in the past, we negotiated the deals by focusing on give and take, a typical zero-sum game mindset. With the ecosystem participants, the typical topic is how to create a long-term and win-win relationship. As we failed to effectively address these challenges in the past years, the company's market position deteriorated. And this competitive edge weakened over time, which is the root cause for the disappointing half year results. With all that said, it's never too late to change. And the time for change is now. As soon as we reach these consensus, we quickly organized a special task force to take action. As an example, we quickly addressed the open dispute with writers over the old version of the writer contract. As soon as we realized that the old contract failed to align China Literature's interest with the interest of our writers' community, we initiated a candid dialogue with our writer candidates to hear their concerns, to hear their opinions and to hear their suggestions. In as little time as one month, we realized -- we released new contacts that align the interest for both parties and stepped up our efforts to fight piracy to better protect writers' rights. All these actions helped us regain the trust of the writer community, strengthen our core business and attract favorable attention from the market already. Looking ahead, we will use the same critical thinking and responsible attitude as a key towards to address issues in the company's other business lines. I think in the -- over the next 6 to 12 months, we will take major steps to improve our content, platform and ecosystem. First, we will enhance resources from IP incubation. No doubt, content of the IP are our core assets, the foundation of our business value and our biggest competitive advantage. By increasing investment in content, we will be able to incubate more and better IP, strengthen our fundamentals and accelerate development across the sectors that will translate into faster growth of our IP portfolio. Secondly, we will introduce improvements to our platform. Our platform is not only a content distribution hub, but also a direct link between writers and the users or readers. We will improve the social and community features of the platform. We will also strengthen the connection capability of our platform by establishing stronger connection between the products of China Literature and the Tencent portfolio to leverage the Tencent's traffic advantage to achieve more intensive user coverage. And finally, we will introduce enhancements to our IP-centric ecosystem. We can leverage our high-quality IP to build business partnerships and networks in a variety of entertainment and content segments, including comics, animation, TV series, films and games, et cetera. We will be able to access both the upstream and the downstream of these segments as well as the respective core user groups. We will also be able to monitor the evolution of the business model of each of these segments. And this will make it possible to be better positioned to capture new opportunities arising from our innovative technology, segment business models and partnership networks. We believe that building up these 3 areas will restore China Literature's fundamentals to health. Over the next few years, we expect to build a brand-new China Literature. We will continue to focus on incubating best content for the most extensive Internet users possible. We will continue to adapt our leading IPs into a variety of entertainment formats from comics and animation, to TV series films, games and even off-line set box. We are also determined to break into new business opportunities by encouraging innovation and the creativity within our organization. We are not expecting a smooth trip to the success. At this moment, we need to take a down-to-earth approach, objectively calculating the difficulties we may face, preparing ourselves for all possible challenges. We will work with our strategic partners, including Tencent, to develop industry -- to develop the industry with more open and positive attitude and invest in our future with greater coverage and patience. We believe that China Literature will enhance its competitive edge and solidify its market leadership as a result in the end. Thank you. And now I'm turning the call over to Xiaonan. Xiaonan, please?

Thank you, Edward. It's my honor to attend our first earnings call since I joined China Literature as President. Edward has defined the high-level strategies, and I will now provide more details on our reading and the IP operation business. As Edward mentioned, the free-to-read model is a challenge to our paid reading model. In the first half of 2020, our MAU and MPU increased by 7.5% and 9.3% year-over-year, respectively. Our growth rates, however, lagged behind major free-to-read service providers. In the past, we have launched our own free-to-read products have failed to reach expectations. I believe we have been relatively too conservative, worrying that the promotion of free-to-read products would dilute our brand reputation for high-quality content. This should be changed because for another perspective, only by gains of market share will we be able to help more users enjoy more quality content. And we can leverage our reach and high-quality library to make this happen. Therefore, we have 2 major goals. First, we will continue to enrich our content incubation ecosystem, which has been our consistent focus over the years. As of June 30, 2020, our library featured 8.9 million writers and 13.4 million works of literature. And around 31 billion Chinese characters were added to our platform over the past 6 months. According to Baidu's search rankings, 25 out of top 30 online literature works were created on our platform. We will continue to build up our premier library by encouraging quality content production. Second, we will adopt a new strategy to drive user growth. We will improve our products portfolio, upgrade our business model, strengthen our cooperation with other platforms, including Tencent and improve our recommendation engine. It is challenging mandate, but we believe that if executed well, it will elevate our online literature business to the next level. Now turning to our IP operations. Through a deep dive analysis in past months, we have identified a number of necessary improvements. For example, we will improve the transparency of our IP pricing mechanism, speed up the adaptation of high-quality IPs into various media formats and build plans for launching franchise IPs. To reach these goals, we need to set up a systematic IP development guidelines and process. And we expect to make progress in the aspects starting from the second half of the year. As the new management team, we are committed to driving a long-term growth of the company and delivering greater value for our shareholders. This concludes my session. I will now turn the call to [ Vivian ] to discuss our financial performance.

Thanks, Xiaonan. In the first half of 2020, our total revenues increased by 9.7% year-on-year to RMB 3.3 billion, primarily driven by the growth of our online business. Our online business revenues were RMB 2.5 billion in the first half of 2020, up 50.1% year-on-year accounting for 76.5% of total revenue compared to 56% in the last corresponding period. The revenue increase was contributed by the growth of our self-owned platform products, which was primarily driven by the expansion of distribution channels as well as using growing willingness to pay for our reading content. However, we continued to see declines in revenues from Tencent products mainly due to drops in our paying users on this product in the first half of 2020. Revenues from third-party platforms was also impacted by drop in revenues from certain distribution partners. In the first half of 2020, we were able to expand our total user base and increase user spending. Our average MAU grew by 7.5% year-on-year to CNY 233 million, primarily driven by the growth -- user growth from our self-owned platform products, which was partially offset by the decrease in MAUs on certain Tencent products. On average, MPUs increased by 9.3% year-on-year to 10.6 million, mainly driven by the growing number of paying users on our self-owned platform products, partially offset by the decrease in paying users from certain Tencent products as more users to our channels to free-to-read content. Monthly ARPU reached RMB 34.1, up 51.6% year-on-year, mainly because we enhanced the depth of our content operations, optimized our recommendation system and expanded our content distribution channels during the first half of 2020. Turning to the IP operations and other businesses. In the first half of 2020, our IP operations and other revenues decreased by 41.5% year-on-year to RMB 765 million, primarily due to the decrease in revenues from NCM during the first half of 2020, which was attributable to the unfavorable external sectors, including the refund adjustment in the film and TV industry as well as the outbreak of COVID-19 pandemic, which impacted the TV and film industry substantially and led to longer production cycles for NCM's film and TV series. Now let's look at costs and expenses. In the first half of 2020, our total cost amounted to RMB 1.5 billion, up 13.3% year-on-year. The majority of which are content costs and platform distribution costs. Content costs increased by 4.9% year-on-year to RMB 584 million, mainly due to an increase in our revenues to be shared. Platform distribution costs increased by [ 214.3 ] year-on-year to [ RMB 619 million ], mainly due to the channel expansion for our online reading content and the revenue increase from our self-operated online game. Production costs of TV series and film rights decreased by 81.1% year-on-year to RMB 68 million, mainly due to the decline in NCM's revenues in the first half of this year. In terms of operating expenses, our selling and marketing expenses were RMB 1.3 billion in the first half of 2020, up 30.1% year-on-year as we invested more marketing dollars to promote our online reading content. Selling and marketing expenses as a percentage of revenue increased to 39% in the first half of [Audio Gap] competitive market. We will make efforts to enhance our IP incubation capability, improve our platform and build a stronger IP-centric ecosystem. We believe that build-up in these 3 areas will help us to restore the healthy fundamentals of China Literature. That concludes the financial-related part. Let's move on to the Q&A session.

[Operator Instructions] And your first question comes from the line of Thomas Chong from Jefferies.

[Foreign Language] I think in the prepared remarks, management has highlighted a number of measures to strengthen the business operations of different segments like the free reading, IP operations as well as NCM. So I'm just wondering how our management will privatize all these strategic priorities. And which ones should we see results in the near term? And what should we expect when all these measures are implemented? How should we think about the long-term trends going forward?

[Foreign Language]

Okay. Let me briefly translate Edward's response to this question. [Interpreted] So after taking over the China Literature management, the new management conducted a deep analysis of the current situation of the company. The company has 2 major business lines. The first one is online reading software in order to meet the readers' demand and also incubate IPs. The second one is very important, since the establishment of China Literature and also the acquisition of NCM, is to unlock IP value through various entertainment formats, including comics, animation, film and TV series, et cetera, the adaptation of IPs. So after the deep and cautious analysis of the current situation of the company, in the future, the KPIs of the management will be focusing on 3 aspects. The first one is continue with efforts on paid reading business model need to be strengthened to incubate valuable IP. And then the second one is we haven't done well in the free-to-read business model. We believe when the market is big enough for free-to-read products that possibly IPs can be incubated through this model as well. So we will increase our efforts in this area as well. And the third one is the NCM. We all know that entered a more stringent macro market environment and policy, we have done some impairment on the goodwill. And in the future, this will be the part we will focus on to unlock the synergies between the 2 companies.

And your next question comes from the line of Eddie Leung from Bank of America Merrill Lynch.

[Foreign Language] So just wondering if you could give us an update on your recent expansion of distribution and user acquisition payments as well as any progress in your advertising business.

[Foreign Language]

Let me briefly translate for Xiaonan. [Interpreted] In general, as a result of the COVID-19 pandemic, the advertisement industry has been impacted a little bit in the first half year. And in our products, we -- our aim is to expand user base ]and increase our user retention. So we try to enrich monetization models and improve user experience. At the same time, we try to get different monetization method, including putting some advertisement in our future reading platform. And also, we also launched a content operation platform with our recent distribution partners. Our recent distribution partners can log on our platform and to attract their followers to our platform to consume content. Under this cooperation, we do not only provide the content but also provide the operational platform and have the pricing right where our recent distribution partners are only responsible for platform maintenance within their official account as well as promotions and user acquisition. Thank you.

[Operator Instructions] And your next question come from the line of Sara Wang from Morgan Stanley.

[Foreign Language] So I have two questions. The first one is on free reading. So you've mentioned that we target to gain market share in the free reading market. So how is our approach to this? So previously, we mainly conduct online -- free reading business on Feidu App. So going forward, is there any change in our channel? And also, how do we operate together or separately with already established paid reading platforms such as Qidian? And second question is on IP operations. So besides drama series production and the new classic media, do we have any update to share with us on, for example, animation or comics adoption and also games? Maybe do we have potential cooperation with other companies under the whole Tencent entertainment ecosystem?

[Foreign Language]

[Interpreted] We realized that only by gaining the market share will we be able to help more users enjoy more quality content, and we can leverage our regional high-quality library to make this happen. So in the future, we will continue to strengthen our advantages in the paying reading model market. And at the same time, we will actively explore free reading business through combining China Literature's advantages in high-quality content and Tencent advantage in user traffic. Thank you.

[Foreign Language]

[Interpreted] Okay. Before my translation for our next question, I just want to clarify the first question that provided by Xiaonan that Qidian, our paying reading app, will still be focusing on paying reading. In addition, we'll invest more on the free-to-read business model. And to answer the second question that -- to translate for Edward. We will collaborate with Tencent's content ecosystem, conducting depth cooperation with Tencent in various areas such as film production, animation production and game development and carry out IP incubation. In terms of film and TV drama production, NCM that has been acquired by us 2 years ago, is one of the best production house in China. And [ joining me ], we promoted Joy of Life that has already demonstrated the success of IP adaptation from China Literature. And we expect more successful cases to happen from efforts of NCM China Literature and Tencent pictures. So in the future, NCM will mainly focus on the development of top-quality projects. And we'll also work closely with Tencent Pictures and also other industry partners because the NCM bandwidth is limited, and it's mostly focusing on top-quality content. So we are very welcome to working with other industry partners to adapt more IPs from China Literature. In terms of animation production, and we can share with you guys that we have already initiated collaboration between the animation team -- comics animation team and Tencent Comics. And we will coordinate with Tencent Comics and other industry partners to turn our literary IPs into visual comics and animation. And we turned -- we think turning our reading apps into animation is the first step for IP visualization and also a very important step in the entire industry chain. In terms of games, in the short term, we will cooperate with Tencent Games and other high-quality game developers and distribute agencies related to major territories in our IPs and we'll be working together with platform, including Tencent on bidding for these. Thank you.

And your next question comes from the line of Xueqing Zhang from CICC.

[Foreign Language] I will translate for myself. The first one is about online reading ARPU. Mostly ARPU [ comprised ] more than 50 percentage year-on-year in the first half of 2020. So wondering what's the new driver for China Literature and how should we think about opportunity in the future? And my second question is regarding IP operation. Could you please share more color on our plan about building an internal team to turn our valuable IP into various content. Thank you.

[Foreign Language]

Let me translate for [ Vivian. ] For the first half year, the growth in ARPU mainly from 2 aspects. One is from the new distribution channels that both in our distribution channel also bring the growth in ARPU. And then the second one is cellphone products. For example, Qidian continued to grow. So the growth mainly from self-operated platform.

[Foreign Language]

[Interpreted] Okay. So our strategy is to focus on incubating more valuable IP and also adapt these IPs into various entertainment formats. So the actual experience and the know-how in different segments is very important. And also the team need to understand how to bring in important industry partners. So this kind of skill set is scarce in the market, not only in China but globally. In the past, China Literature were more focusing on development within each segment. And it is a challenge to run cross-segment development. And that's what we're going to focus on in the future. So we have already started the progress of building a team that is familiar with the -- in vision know-how and the cross-segment collaborations, and we expect to show more positive results in the future.

And your next question comes from the line of Brian Gong from Citi.

[Foreign Language] Okay. I will translate myself. So I have noticed that without the leading channels on mobile [ platform the ] program on Tencent News. I was wondering if this is a new area where will we expand our paid reading business. If that's the case, how much distribution costs will we give to Tencent? And if there is new writers, what's the profit share mechanism with writers? And the second question is regarding the marketing costs. So the marketing cost surged allowed in the first half of the year. So it seems that we didn't spend too much money on printing this year. So just wondering what's the reason behind the increase and how we should see the trend going forward?

[Foreign Language]

[Interpreted] So the main -- our strategy is to leverage on Tencent traffic to bring China Literature to IPs to more user base because the channels you have mentioned from Tencent actually are targeted to a different user group and different audiences. And the core strategy is to bring more user base to China Literature and to integrate and leverage on Tencent's traffic base. At the same time, it's very important to guarantee the writers' benefits. So all our works have been licensed -- authorized by the writers. And we can also see that we are -- saw that the contracts -- cost of the contracts did do very well, and we have gained support from the writers. So the new management efforts are targeted to creating more synergies between China Literature and also Tencent platform, of course, on the condition of guaranteeing the writers' benefits.

[Foreign Language]

[Interpreted] So the S&ME expenses increase were mainly from our 2 -- driven by 2 reasons. The first one is we're putting some resources to acquire users, and that has driven our growth in our self-operated platform. And the second factor is that we have put in some resources to promote our games. So that were the 2 reasons that increased our S&ME expenses.

And your last question comes from the line of [ Erin Tonglan ] from TF Securities.

[Foreign Language] We noticed that revenue for Tencent [ closed out ] the channels and so [ third party ] continued [ decreasing. ] What's our strategy to the 2 channels in the future?

[Foreign Language]

[Interpreted] We agree that we have more challenge on the third-party channels because the third-party channels, they're primarily relying on external platforms. And currently, they are focusing on paying and reading model as well. So in the future, we have combined paying reading habit of -- paying reading content and also free-to-read content. And also, we -- our business focused on licensing our self-owned platform products in Tencent channels since we have a better control and closer relationship of these 2 channels.

[Foreign Language] We have bought -- we know that [ movies ] have done very good down to the drama series. And what's our attitude to sale products?

[Foreign Language]

[Interpreted] To the movie business, the movie business was impacted largely by the COVID-19 pandemic. The theaters haven't yet resumed operation to the full extent. And to our understanding, only 30% to 50% has been recovered. And the release dates of movies still cannot be fixed. And we will -- so many projects haven't decided on the releasing date. As a result, we cautiously adjusted our strategy towards movies in the short future. And we have a very rich inventory in film production. However, we will keep a closer look on the pandemic to see whether there's any recurrence on the pandemic and to decide our crucial pipeline of the -- of our movie business. And also, because the audience posted ongoing safety concerns to movie audience, so we will decide along with the development of the pandemic. Thank you.

Thank you, everyone. Due to the time constraints, we will now conclude today's call. On behalf of the entire China Literature management team, I would like to thank you for your participation on today's conference call. If you have further questions about the company, please feel free to contact us. Thank you, and goodbye.

Thank you.

Thank you.

That concludes the conference for today. Thank you for participating. You may all now disconnect. [Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]