China Literature Limited (772) Earnings Call Transcript & Summary

Good evening, ladies and gentlemen. Welcome to China Literature's 2021 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 at China Literature. Maggie, please go ahead.

Thank you, operator. Ladies and gentlemen, welcome to our 2021 interim results conference call. Joining us today on the call are Mr. Edward Cheng, our CEO; Ms. Monkey Hou, our President; and Mr. William Sun, our VP of Finance. For today's call, Edward will discuss the company's strategies, Monkey will review the company's business, and William 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 may not be realized in the future for various reasons. Information about general market conditions is coming from a variety sources outside of the company. This presentation also contains some unaudited non-IFRS financial measures that should be considered in addition to but not 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 2021 interim results earnings release. I will now turn the call over to our Chief Executive Officer, Edward.

Ladies and gentlemen, thank you for joining our earnings call today. I'm pleased to share with you what we have learned in the past 6 months and more importantly, what we plan to do operationally and strategically to build the next phase of China Literature. Six months ago, during our 2020 annual results conference call, we focused our discussion on 2 topics. The first topic was how to tackle operational challenges at that time. And the answer was to focus relentlessly on 3 key areas: content, platform and ecosystem. We believe that the overall enhancement of these 3 areas will defend our leadership today. And the second topic was to ask ourselves what was the value driver of future growth. The answer was IP development with a growing universe of IP franchises that could deliver long-lasting value over time and shape what China Literature would become more of. Based on this belief, we instituted a reorganization to support actions and decisions with a view to long-term aims. Another way of putting this was that we should look at our business through 2 lenses. One lens will focus on precise and efficient execution as a response to day-to-day challenges. The other will bring out the critical value of storytelling by looking deeply into the history and future of our ever-evolving social and cultural dynamics with storytelling the link between the deep values and the physical connections from one generation to the next. This dual approach to value creation has guided us since the second half of last year, and we believe we are on the right track. Now we are experiencing the payoff of unique strategic framework. During the first half of 2021 our total revenues increased 33% to RMB 4.3 billion year-over-year. Revenues from the segment of IP operations and others increased by 125% to RMB 1.8 billion, accounting for 42% of total revenues. Our IFRS net profit was RMB 665 million, an increase of 30x over RMB 21.7 million in the corresponding period last year. Together with this encouraging result, we found out our content and platform leadership continued to grow. As discussed, literary content and platforms are both critically important. Metrics in these 2 areas measure our ability to produce high-quality reading content and to generate our reach -- user reach and engagement. Let me share with you some details. During the first half of 2021, both the number and the quality of our writers and literary works continued to increase. As of June 30, 2021, China Literature had more than 9.4 million writers on the platform with a total of 14.5 million literary works. Over 18 billion Chinese characters were added to our platform during the first half of this year. According to the search engine Baidu's search rankings, in June 2021, 17 of the top 20 online literary works originated from our platform. The market share of our high-quality works is higher than our market share in terms of the number of users, which reflect the excellent ability of our platform to incubate primary -- prime literary works. Amongst the active users, MAU of our online business amounted to 233 million, an increase of 3.7% from the previous 6 months and approximately the same year-over-year. The user traffic on our platform peaked during COVID-19 pandemic outbreak early last year and experienced some pullback in the second half of 2020, which was quite normal as overall online user traffic dropped. However, during the first half of 2021, our MAU regained momentum and approached the peak level last year. It benefited from emerging top-notch content, enhanced community operations, increased efficiency of our recommendation system and the growing popularity of our free-to-read business. In June 2021, daily active users, DAU, of our free-to-read business reached 13 million, an increase of 30% compared to December 2020. During the first half of this year, China Literature and Tencent set up a joint project team to promote the free-to-read business and to facilitate cooperation within the Tencent ecosystem in a very -- in a more efficient manner. Our free content creation platform also contribute -- continue to produce high-quality free novels and attract more and more writers. Leadership in both content and platform ensures that we can generate quality literary IPs continuously under our mechanism. The next big question is given the numerous high-quality IPs we already own and will create in the future, how to build an ecosystem to increase the value of these IPs during their lifetimes. Specifically, when we're converting a literary IP into other media formats, the content needs to be reimagined. The new recreated content has to be distributed over different channels. And the monetization model has to be redesigned to unleash the full power of the IP. Using analogy, we would call this process a metamorphosis of the original IP. Stage 1 of the metamorphosis comes through the conversation (sic) [conversion ] of literary IP into media-rich products such as comics, animation, movies, TV dramas and games. The combination of sound and the visual effects and potentially digital interactions essentially expand the user base and redefine the user experience for the same IP. Based on a common story line, creative artists from each media segment can add their own touch to create unique audience connections and increase the impact of the original IP. From 2020 onwards, China Literature has been actively working with external teams while also building its own capabilities in content conversation -- conversion and has made significant progress. And just to give some examples. In the comics segment, China Literature Comics & Animation Department and Tencent Comics jointly announced a 3-year project to adapt at least 300 works of online fictions into comics. Currently, more than 70 of our literary works has already been adapted into comics and released on Tencent Comics' platform. In addition, we will collaborate with Kuaikan Comics, another leading online comics platform, to adapt 30 online literary works into comics. In the animation segment, we continue to produce and launch animated series adapted from our IP. Among them, the semi-annual animation work adapted from our popular title Battle Through the Heavens generated over 1.9 billion video views and gained 7.8 points on Douban.com. We currently have more than 50 animation projects in pipeline, including animated series adapted from top-tier IPs such as Dafeng Guardian, Forty Millenniums of Cultivation, The First Order and World's Best Martial Artist. In the film and TV drama segment, which draws everybody's attention, the drama series My Heroic Husband, [Foreign Language], jointly produced by New Classics Media, Tencent Pictures and China Literature Pictures, was one of the year's blockbusters. It ranked #1 on many TV series ranking charts and won praise from respected critics. Another drama series, Soul Land, [Foreign Language], topped Tencent Video's hot search list and TV series list during its broadcast period, enjoying very wide market popularity. The Rebel, [Foreign Language], ranked #1 on the playlist of the Enlightent’s TV series, #1 on Guduo’s hot list for TV series and was most watched program on prime time on CCTV-8 for 20 consecutive days. The drama series was also widely acclaimed by viewers and gained 8.3 points on Douban.com. As for films, New Classics Media participated in the production of the hit movie Hi, Mom with box office sales of over RMB 5 billion, the second highest ranking box office sales ever in the history of the China film industry. Looking forward, China Literature, New Classics Media and Tencent Pictures will continue to work together closely and focus on serial development of premium IP franchises, including Joy of Life, [Foreign Language]; My Heroic Husband, [Foreign Language]; and Dafeng Guardian, [Foreign Language], as well as launching high-quality contemporary-themed TV series like A Lifelong Journey, [Foreign Language]. We will also explore opportunities with new areas such as online movies and short dramas. In the games segments, Lord of the Mysteries, [Foreign Language]; A Record of a Mortal’s Journey to Immortality, [Foreign Language]; My Heroic Husband; and other high-quality IPs have been licensed already to industry-leading game developers. And the games adapted from these IPs will be launched sequentially sometime in the coming several years. The second stage of IP metamorphosis is to evaluate the commercial value of IP. We hope our premium IP will walk out of connected screens and digital devices into every consumer's everyday life in various types of products and services. Currently, the influence of Chinese IP is still at an early stage while the global IP licensing and merchandising industry is still leading -- is still led by entertainment giants from the U.S. and from Japan. The top ranking Chinese IP licensor in the global market is #39 according to [ RTAP ]. We believe in the long-term vitality and great commercial prospects of Chinese IP. At the beginning of this year, China Literature established an IP Power Center to promote the visual characters created based on our premium IP content, starting with those that have already established a wide user base. We will build symbiotic relationship with our upstream and downstream partners to explore new opportunities such as IP licensing in consumer products, fashion toys and offline business. We hope China Literature will become one of the top IP licensors globally in the future. The third stage of IP metamorphosis is where IP and the characters from the IP are not only connected to but become an integrated part of the life experience of consumers. At this stage, IP is ever useful and can be passed down from one generation to the next, and this is our target. We hope to create IP that can grow together with audience, bearing a unique timestamp from its date of creation but evolving over time. For example, the Handsome Monkey King in the '50s was Liu Xiao Ling Tong in China. While The Monkey King in the '80s was Stephen Chow, Chow Sing-chi. Each character is distinct but both a classic. We hope that the relationship between China Literature's IP and the consumers is interactive, intimate, enduring and eventually inseparable and invaluable. The two stages of metamorphosis, the conversion of IP into media-rich formats and the increase in monetization value of IP, support stage 3, that is actually immortality. Our leadership in content and platform and our understanding of the metamorphic potential for our IP forms the solid foundation for our mission, which is to create good stories that will live a long time, maybe forever. The ultimate goal of China Literature IP ecosystem is to create compelling and inspirational stories. The success of this goal relies on China Literature's online platform to discover and distribute premium literary IP. It also relies on an open and inclusive ecosystem within reach, creative talent and business partners collaborating seamlessly to promote IP metamorphosis and unleash the full power and the commercial value of the best IP. To get there, in the near term, we will focus on 3 things. First, we will make China Literature an infrastructure of talent and for talent. We will identify and nurture creative talent through the entire IP ecosystem, from writers, animators to directors and playwrights. Secondly, we will tell stories visually and create convincing characters out of our premium IP. The successful experience of China Literature in animation, films and television help prove that the media-rich format can amplify monetization of the IP. We will build up our in-house production capabilities. We will also, at the same time, cooperate more openly with leading industry partners to enhance the impact of our IPs. Thirdly, look at IP development as a long-term project. For each premium IP, we should tailor-make a development plan and pick up the most appropriate partners to work with over time. We will continue to upgrade and strengthen our organizational capability and enhance the long-term operating opportunity of our IP through various mechanisms such as [ mid-platform ] construction, external partner, joint decision-making and [ go-live ] committees. China Literature's vision is to become a world-leading platform for cultural creativity. Down the road, we will build an unparalleled collection of IP franchises and characters that will unite with the users across their daily lives. We will assemble a strong army of creative talent that delivers not only various formats of entertainment products and services but also bring the IP and its characters to life. China Literature from day 1 has been an organization built by creative talent. We will continue to maintain our support for the talent to bring out their maximum potential. Their ideas, combined with our business network, will be brought to consumers in the form of creative products that no one has ever seen before. In sum, we believe the success of our IPs and our creative talents will eventually make China Literature the top culture and entertainment group globally. That concludes my session. Now I would like to invite Monkey to continue our business presentation. Thank you.

Thanks, Edward. Edward has discussed our strategy and provided some key business updates. Let me add more details about our business development. First, let's look at our online business. In the first half of 2021, total MAU of online reading business was relatively stable year-over-year at 232.7 million. Average DAU for our free reading content was up 30% from last December to 13 million in June 2021 as we continued to expand our free reading business and attracted more users to free content. Average MPU for our paid reading content decreased 12% year-over-year to 9.3 million. However, our monthly ARPU increased 7% year-over-year to RMB 36.4 as we further improve our content operations, enriched community features and improved recommendation system for paid reading products and our paying users showed greater interest to pay for high-quality content. While strengthening our reading community and user engagement, we also improved the content and the quality of work on our platform. We will continue to advance our online reading business through both paid and free business model. Turning to the IP operation business. During the first half of this year, we licensed around 190 IP rights for adaptation to partners. Besides our top ranking film and drama series, as Edward has mentioned, we released a number of adapted animated series, including new seasons of Full-Time Magister [Foreign Language]; and Battle Through the Heavens, [Foreign Language], which received positive feedback from large audience. This concludes my session. Now I will hand over to William for the financial performance. Thank you.

Thanks, Monkey. Hello, everyone. The first half of 2021 saw a strong reduction of top line and bottom line growth compared to the same period in 2020. Our total revenues increased by 33.2% year-over-year to RMB 4.3 billion. Our online business revenues were RMB 2.5 billion, up 3.4% year-over-year, accounting for 58.5% of total revenues. The revenue growth was attributed to an increase in advertising revenues as we expanded our free-to-read business. Additionally, we experienced an increase in revenues from third-party platforms. And certain existing platform partners performed well, and new distribution channels were added. These increases were partially offset by a decrease of 5.5% in revenues from our self-owned platform products in the first half. Revenue base was higher last year due to a rise in online traffic during the COVID-19 pandemic period. Turning to the IP operations and other business. In the first half of 2021, our IP operations and other revenues increased 124.5% year-over-year to RMB 1.8 billion primarily due to the growth in revenues generated from our TV and web series, films, IP licensing and self-operated online game business during the first half of 2021. Now let's look at costs and expenses. In the first half of 2021, our total cost of goods sold amounted to RMB 2.1 billion, an increase of 34.4% year-over-year. The main 3 components of the increases were: one, higher content costs as we expanded our IP licensing and free-to-read business; two, higher production cost for TV series, web series and films that went along this revenue increase; and three, higher amortization of intangible asset of content copyrights. In the first half of 2021, our gross profit increased by 32.2% year-over-year to RMB 2.3 billion, representing a gross margin of 52.7% compared with 53.1% in the first half of 2020. We recorded net other gain of RMB 901 million for the first half of 2021 compared with net other losses of RMB 3.5 billion in the first half of 2020. Net other gain for the first half of 2021 consists of: one, a gain of RMB 1.1 billion related to the sale of our equity interest in Lazy Audio; two, gains of RMB 134 million on disposal of certain intangible assets; and three, fair value gain of RMB 55 million resulting from increased valuation of investee companies. These gains were partially offset by a fair value loss of RMB 383.2 million due to a change in fair value of consideration liabilities related to the acquisition of New Classics Media. In terms of operating expenses, our selling and marketing expenses were RMB 1.3 billion in the first half of 2021, up 6.1% year-over-year, driven by greater promotion and advertising expenses for our films and drama series during the first half of 2021. Selling and marketing expenses as a percentage of revenues decreased to 31% in the first half of 2021 from 39% in the first half of 2020. Our G&A expenses increased 81.1% year-over-year to RMB 635 million in the first half of 2021, primarily due to a reversal of compensation costs of RMB 117 million related to the service expense of certain employees and former owners of New Classics Media in the prior period of last year; and increased expenses for employee benefits, research and development and office, travel and entertainment. As a percentage of revenue, our G&A expenses were 14.6% in the first half of 2021, up from 10.8% in the first half of 2020. As a result of the factors mentioned above, our operating profit was RMB 1.3 billion compared to an operating loss of RMB 3.6 billion in the first half of 2020. Non-IFRS operating profit, which excludes share-based compensation, M&A-related impacts such as net gains from investee companies and amortization of intangible assets, was RMB 641 million with the non-IFRS operating margin of 14.8%. Our net profit was RMB 1.1 billion, and our non-IFRS net profit attributable to equity holders of the company was RMB 665 million with the non-IFRs net margin of 15.3%. In conclusion, our business yielded strong performance in the first half of 2021, benefiting from effective execution and our growth strategy. That concludes the financial-related part. Let's move to our Q&A session.

This Q&A session is not intended for the media. Media representatives will be able to participate in listen-only mode. [Operator Instructions] Your first question comes from the line of Thomas Chong of Jefferies.

[Foreign Language] Congratulations on a very strong set of results. I have 3 questions. The first question is about our free reading initiative. Given that we have seen a 30% growth in terms of the DAU to 13 million in the first half, can management comment about the future user growth driver as well as the advertising potential? And my second question is about NCM. Given the strong performance in the first half, how should we think about the second half outlook as well as 2022 drivers in terms of revenue and profitability? And then my final question is about our online reading business. Can management comment about the user growth trend, revenue and profitability drivers in second half in 2022?

[Foreign Language]

[Interpreted] Okay. So thank you for the question. And I will take your questions as to the free reading business and the growth drivers. And as to the question [Audio Gap] from NCM will take this question. So first of all, as you can see, the DAU for our free reading business in June this year reached 13 million. So currently, our focus on free-reading business is on user coverage expansion, and we expect to see a continued user growth. On one hand, we have established a joint project team to promote the free-to-read business and to facilitate channel cooperation within the Tencent ecosystem in a more efficient manner. On the other hand, our free content creation platform also continues to produce high-quality free novels attractive to users. I think you might also be very interested in our monetization level. At this moment, the upload is strategically limited and monetization is still restrained. Our current business focus is on user base expansion, user retention enhancement and high-quality free content incubation and selection, which are very important foundations for monetization. So in the future, when we think that the user coverage is sticky and considerably as mature, we will gradually increase the upload and increase the monetization level and at the same time, balance it with user experience.

[Foreign Language]

[Interpreted] So as to your question about the growth engine in the future, I will discuss in 2 halves: first of all in terms of the reading business. The focus of our online reading business is consolidating good writers and quality content to set a solid foundation in users and content IP operations. This is also our core competitive advantage. As to the pay-to-read business, we will continue to conduct in-depth operations in content innovation, genre diversification and incubation of generation Z writers. We will further enhance community operations by launching more community features to strengthen the interesting elements in our community, increase user engagement and stickiness. In addition, we'll improve user satisfaction due to the continuous improvement in our recommendation engine. While solidifying our paid reading business, we will actively explore opportunities in free reading business as well as free reading model could bring us more users, which we believe is also very important. So the free-to-read business is also a potential for our business. As to the free-to-read business, our current focus is build on user base expansion, user retention enhancement and high-quality content incubation.

[Foreign Language]

[Interpreted] So next, let me talk about our IP business outlook. So our strategy is to openly collaborate with business partners across the entertainment industry to build up a symbiotic ecosystem. Our online literature business will be cornerstone that provides a large library of prime IP, and IP development business will be the growth accelerator. We believe that in the long run, IP business will contribute more revenue growth and account for bigger portion in our total revenue with quicker growth rate than the online business. In the short term, drama series, films and IP licensing will be the major revenue contributors, and anime is strategically important for its ability to quickly [ materialize ] literary IP for market validation in spite of relatively small revenue size. In the mid to long term, we expect the game revenue to increase and bring us more room to grow. From an even longer-term perspective, we also expect the IP merchandising and offline consumption to contribute larger revenues.

[Foreign Language]

[Foreign Language]

[Interpreted] Okay. Let me introduce the growth driver for NCM in the second half of year and the next year. So we expect a total of 4 to 5 drama series to be released in the second half of this year, including the Demi-Gods and Semi-Devils, [Foreign Language], which is now being broadcasted on CCTV-8 and Tencent Video. Apart from that, we expect other projects to be released, including Sword Snow Stride,[Foreign Language]; In Spite of the Strong Wind, [Foreign Language]; I Am a Superstar, [Foreign Language]; [ Mystery of Antiques ], [Foreign Language]. We expect to release a total of approximately 6 to 8 drama series in 2022, including A Lifelong Journey, [Foreign Language]; [ A Princess Lawyer] , [Foreign Language]; The Wind Blows From Longxi, [Foreign Language]; [ War Rose ], [Foreign Language]; Battle Through the Heavens season 2, [Foreign Language]; [ The Infiltrator ], [Foreign Language]. So in addition, we will also have 1 to 2 movies in 2022 pipeline. The revenue and profit growth comes from NCM's abundant and high-quality pipeline. NCM Will consistently execute on the strategy of producing high-quality, diversified and serialized content and ensure product quality while pursuing better financial performance. The profit target set in the earn-out mechanism revised last year could be a reference to its profitability in the next few years. Thank you.

Your next question comes from the line of Xueqing Zhang of CICC.

[Foreign Language] You just mentioned the first stage of IP metamorphosis, and the second stage is related to IP licensing in consumer products, fashion toys and offline business. Considering we have invested on a live-action role-playing game platform, could you please give us more color or details?

[Foreign Language]