Kuke Music Holding Limited (KUKE) Q2 2021 Earnings Call Transcript

Kuke Music Holding Limited (KUKE 5.69%)
Q2 2021 Earnings Call
Aug 04, 2021, 7:30 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning and good evening, ladies and gentlemen. Welcome to Kuke Music Holding Limited's second-quarter 2021 earnings conference call. At this time, all participants are in a listen-only mode. We will be hosting the question about this recession after management's prepared remarks.

Please note, today's event is being recorded. I will now turn the call over to the first speaker today, Ms. Jane Zuo, investor relations director of Kuke Music Holding Limited. Please go ahead, ma'am.

Jane Zuo -- Investor Relations Director

Thank you, operator. Hello, everyone. Welcome to our second-quarter 2021 earnings call. On the call with me today are Mr.

He Yu, founder, chairman, and CEO; Ms. Patricia Sun, the president; and Mr. Tony Chan, CFO of Kuke Music. Mr.

Yu and Ms. Sun will review our business operation first. And then, Tony will discuss our financial details. Afterward, we'll take questions from the audience.

Before we start, please note that this call may contain forward-looking statements made pursuant to the safe harbor provision for the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on management's current expectations and observations that involve known and unknown risks, uncertainties, and other factors not under the company's control, which may cause actual results, performance, or achievements of the company to be materially different from the results, performance, or expectations implied by this forward-looking statements. All forward-looking statements are expressly qualified in their entirety by the cautionary statement, risk factors, and the health of the company filings with the SEC. The company undertakes no duty to revise or update any forward-looking statements for selected events or circumstances after the date of this conference call.

As a reminder, this conference is being recorded. In addition, a live and archived webcast of this conference call will be available on the Kuke investor relations website at ir.kuke.com. You can check out our full earnings release on our IR website as well. It's now my pleasure to introduce Mr.

He Yu, founder, chairman, CEO of Kuke Music.

He Yu -- Founder, Chairman, and Chief Executive Officer

Thank you, Jane. Hello, everyone, and thank you all for joining us, and welcome to our second-quarter earnings call. I'd like to start by sharing some thoughts on recent industry trends and our overall strategy. We believe that classical music is an art from -- in which classic works are preserved from various historical periods.

These classical music works of art are mainly recorded and disseminated through sheet music. Its beauty is embedded in its elegant structure and informality, giving it much stronger lasting value. Classical music is the foundation of musical learning. In addition, classical music as an art subject promotes strong logical thinking.

Musical concepts of reason and harmony are closely tied to men, which shows why musical studies can be integrated with other subjects to enhance the learning foundation for students. Many scientists including Albert Einstein, Stephen Hawking, [Inaudible] have studied foundational music knowledge. As the only listed company focusing on classical music, we leverage our ever-growing copyrighted music content library and technological innovation to improve the efficiency and the penetration rate for people to subscribe and learn classical music. Recently, several government policies changes have been focused on enhancing arts learning.

The State Council of the PRC and the Ministry of Education have issued a series of important guidelines on development and foundational arts learning as one of the key development areas for quality education in schools. According to the Ministry of Education's interpretation of the relevant guidance documents on arts learning issued by the State Council in October last year, schools of all levels will need to include the music and art lessons by 2022. At the same time, it is necessary for all schools to improve student evaluation in art learning and to add art as an exam subject for junior and senior high schools. Many provinces including Hunan, Jiangsu, Yunan, and Hainan have already responded to this policy, stating that they will add music and arts in high school entrance examinations or expand related pilot projects.

Going forward, we believe the Ministry of Education will guide the local schools to continue improving resource allocation and increasing the coverage of arts learning courses. Eventually, we believe that arts learning will be included in the evaluation system of China's double first-class universities. Preschool children are the largest target group for arts learning instruction and they are also at a better stage of development to absorb arts learning. According to the Ministry of Education of the PRC, in 2020, there were 537,100 schools and 289 million students.

Among them, 291,700 are kindergartens with roughly 48 million children enrolled, 218,800 are primary and secondary schools with 156 million students enrolled. As the leading classical music content provider in China, we support and follow the national policy guidance to promote the development of foundational music instruction. In addition, we continue to focus on classical music licensing subscription, smart music content, and system development to create a smart music ecosystem. We own the licensing rights for more than 900 record companies and labels in the world including Naxos.

We have also developed the Kukey smart piano, digital music learning content, and an associated SaaS system. On July 23, we announced a strategic cooperation agreement with People's Music publishing house. The two parties will work together to establish the music -- People's Music and the Naxos Global Platinum Record Program of China and the Global Resource Co-construction Plan for the National Aesthetic Education Research Music Encyclopedia Interdisciplinary courses. Meanwhile, we will explore various cooperation opportunities with our music licensing resources.

Notably, People's Music and Naxos Global Platinum Record Program of China is our first cooperative program with People's Music in China. The program selects orchestral, chamber, vocal, and national orchestral music from young Chinese composers around the world to provide them with a broader platform to share their music via the record album format. Meanwhile, we will take our combined advantages to establish a high-quality editorial team to launch interpretive interdisciplinary courses that enhance music-related activities. By enhancing art learning for teenagers, the courses will foster independent thinking and creativity while helping students boost their cultural literacy.

As schools and students gradually come to understand the importance of music learning, we continue to actively export they explore music services based on student needs. Empowering them with technologies to improve both the student and the teacher experience while improving the quality and efficiency of the music lessons. We are confident that our visionary business strategy, which focuses on music rather than the traditional academic subjects, and in-school earnings rather than after-school lessons. Along with the support of the government's policies, we'll continue to review our development going forward.

Our director Yu Long, one of the most influential conductors in Chinese classical music once stated, "China has become an indispensable part of the big family of classical music, and there is no better way of building connections than through a cultural exchange." On July 27, we announced the timing and the theme for the 24th Beijing Music Festival. 2021 marked the anniversary year since the passing of many great composers including Igor Stravinsky, Camille Saint-Saens, Astor Piazzolla, Gustav Mahler, and Arnold Schoenberg as such. The theme of the 24th BMF is "Masters and Memorials." Musicians will express their understanding of the theme through a set of 18 performances in 20 different shows across 16 days in October. We aim to provide a platform for young Chinese musicians to express their musical voices to the world.

On July 28, we leveraged our industry resources and networks to develop a program for China's teenage musicians called the Qing Pei Talent Show. This program was to help Chinese teenagers enter the classical music field, discover more classical musical talents, and form a closed-loop industry chain. We invited many industry experts to join the Performing Arts Committee including Chen Leiji, the famous guqin player; Wu Ying, the president of the Chinese Musicians' Association, Piano Society, and now professor of the Central Conservatory of Music. The program included seven different performances categories including keyboard, orchestral music, and percussion.

Music -- musicians and artists ranging from kindergarten students to young adults from art schools and universities were all will come to join. This program provides a great platform to present high-quality artwork, connecting young people from all across the country throughout, and promote the sound development of quality Chinese art training. Next, I will pass it over to our president of folk music, Patricia, to provide more insights across all business segments. Thank you.

Patricia Sun -- President

Thank you, Mr. Yu. Good morning and good evening, everyone. Our second-quarter results were characterized by a robust recovery in the business, stellar revenue growth, and improved profit margin.

We experience some notable growth in all three business segments. Our licensing and subscription revenue in the second quarter reached RMB 39.6 million, representing a year-over-year increase of 3.3 times and a quarter-over-quarter increase of 7.6 times. In the first half of 2021, we've continued to expand our library of audio-video and online masterclass content effectively attracting more customers to purchasing our content licensing. Our audio and video classic music catalog added more than 80,000 tracks, reaching more than 2.7 million pieces of content in total, which increase -- includes more than 2.3 million music tracks and 410,000 long-form concert videos and audiobooks.

The music genre in our catalog includes classical, jazz, world, country, and Chinese folk music. Moreover, we added more than 3,000 pieces of digital sheet music to our catalog. During the first half, we further diversified our music offerings by introducing not only the various types of musical instruments but also music from multiple countries in the region. The type of musical instruments featured in our music catalog has increased from 2,000 at the end of 2020 to 2,077 as of June 30, 2021.

Newly added instruments include unique instruments such as alto flutes and berimbau. The countries and the region featured in our music library also grew to 266. Meanwhile, the number of foreign audiobooks increased by more than 5,000 to over 410,000 during the quarter. As we enrich our music offerings, we also provide an ever-increasing music content library for our streaming platform and other corporate customers.

In addition, we produce diversified thematic content that is clearly based on the different needs of each collaborating platform, utilizing the preferences of listeners from different age groups. Moreover, we've cooperated with artists to produce interviews and video content to increase our exposure to -- increase their exposure on streaming platforms. Through continued refinements of -- refinement of operations and product iteration, the number of downloads clicks and shares for our music content on cooperative digital service platform have further improved. For example, in April, we worked with our collaborative platforms to promote our recording artists who joined at the International -- National Centre for the Performing Arts Orchestra Six-City Nationwide Tour in order to promote the sales of their digital albums and related content.

Late in June, we launched a one-month online event to promote recording works of Chinese artists and enhance the interaction between artists and listeners. During the second quarter, we introduced Kuke music box, classical music learning guide, and audio product based on the Chinese Naxos MusicBox product. Going forward, polka music box will be updated periodically and will be exclusively available on the Himalaya platform. In addition to adding music tracks, we hope to produce instructional content to improve classical music literacy for our users, helping them improve their ability to appreciate the delicacy of music, improved musical tastes, and introduce greater enjoyment in listening to classic music.

As a result of the expansion of our music offerings, our library subscribers have also increased. In the second quarter, we signed a contract with five new public libraries. By the end of the second quarter, we have 775 universities and library customers. In terms of our smart music learning solutions business, revenue in the second quarter reached RMB 20.6 million, representing a year-over-year increase of 34.2 times and a quarter-over-quarter increase of two times.

Launched in the fourth quarter of 2019, our in-school Kukey AI process has successfully centralized and digitalized the music learning process, which previously was highly individual and pledged by a constant quality. By utilizing AI technology in the cloud infrastructure, we are able to digitalized traditional teaching tools into our SaaS system while storing content updates and the data in the cloud for further refinement and data analysis. Each of our smart pianos serves as an intelligent terminal that sends and receives data to and from the cloud where the data is processed and analyzed. This business model not only streamlines our operations but also addresses the most significant time and cut the barriers that students and their families face when trying to learn piano.

Kukey online group interactive courses remove the need for private piano rooms, eliminating the expensive cost of renting space. The students' tuition costs are further reduced as teachers only need to supervise students during class. Families no longer need to purchase a piano or pay transportation costs to attend classes or commit time investment or commute to attend lessons. With well-rounded music learning in mind, Kuke further leverages its advantages in the music industry value chain to provide students with opportunities to participate in music competitions, explore their musical talents, and even pursue professional music learning development.

As of June 30, 2021, our collaborating kindergartens grew to more than 4,500 from 2,500 as of March 31, 2021. During the quarter, we added 2,069 collaborating kindergartens to our network. The number of active Kuke students increased to 33,000 from 5,300 during the second quarter of 2020, and our geographic coverage has expanded to 234 cities. In the second half of the year, we will launch a domestic version of the smart piano for customers.

This version of the product will feature a comprehensive piano teaching system, which includes Naxos master-level teaching content titled My First Piano Book. A powerful digital music sheet library, smart piano practice services, and a music club catalog, which contains classical music, audiobooks, and children's songs. For all music events segments, revenue in the second quarter reached RMB 23.8 million, representing a year-over-year increase of 83.2 times. During the quarter, we provided planning and execution services for 13 commercial performances of six local Chinese orchestras.

Our planning and execution services are recognized under this segment and service -- and served as an important measure to add value for our downstream main settings and industry partners. In light of increasing demand in the music industry and the recovery of the market economy in the post-academic era, we will continue to expand our classical music library; develop smart piano hardware, content, and systems; plan and launch music events permissible under the PopTech gathering restrictions and actually explore on your business initiatives to increase our business synergies and form a closed-group industrial chain. With that, I will pass the call over to our CFO, Tony, who will walk you through our commercial details for the quarter. Thank you.

Tony. 

Tony Chan -- Chief Financial Officer

OK. Thank you, Patricia. Yeah. Thank you, Patricia, and hello, everyone.

Before we start our detailed financial discussion, please note that we will present on IFRS measures today. Our non-IFRS results exclude certain noncash expenses which are not part of our core operations. Details for these expenses can be found in the reconciliation tables on our press release. Please note that unless otherwise stated, more financials -- financial numbers we present today for the second quarter of 2021 are in RMB terms.

All comparisons on a year-on-year basis unless otherwise stated. During the second quarter of 2021, our revenue increased by 732% to 84.1 million from 10.1 million in the same period of 2020. This increase was driven by revenue growth in all three of our business segments. Revenue from our smart music learning solutions business increased by 34.2 times to 20.7 million from 0.6 million in the same period of 2020, mainly due to robust growth in the number of customer contracts secured during the quarter.

Licensing and subscription revenue in the second quarter was 39.6 million, compared to 9.7 million in the same period of 2020. This increase reflects a recovery in demand from music streaming by institutional subscribers supported by increases in the company's music content offerings. Revenue from music events business also increased to 23.8 million from 0.3 million in the same period of 2020 due to our new music event planning and execution services. Total cost of sales increased by 399.6% to 34.4 million.

A modest increase related to the increases in our revenue. Gross profit was 49.7 million, representing an increase of 14.4 times from 3.2 million in the same period last year. Gross margin improved to 59.1% from 31.9% in the same period of 2020. The improvement in gross margin was mainly due to greater economies of scale as revenues of our licensing and smart music learning solutions business grew at a much faster pace than the relative costs.

Operating expenses were 59.5 million, compared to 13.9 million in the same period of 2020. Selling and distribution expenses were 13 million compared to 6.3 million in the same period of 2020, mostly due to an increase in distribution expenses associated with increases in sales of our smart music learning solutions. Meanwhile, administrative expenses were 37.5 million, compared to 10.3 million in the same period of 2020, mainly due to an increase in share-based compensation expenses and research and development expenses. Operating loss in the second quarter was 8.4 million, compared to 9.6 million in the same period of 2020.

Our net loss for the period was 11.4 million, compared to 9.7 million in the same period of 2020. And non-IFRS profit was 18.3 million, compared to a non-IFRS loss of 10.3 million in the same period of 2020. Basic and diluted loss per ADS were both 0.42. Basic and diluted by non-IFRS profit per ADS were both 0.62.

Moving onto our balance sheet and liquidity. As of June 30, 2021, we have a total of RMB 153.3 million in cash and cash equivalents. We are on track to achieve our full-year revenue target of not less than RMB 400 million. And we expect our business activities to continue improving for the next two quarters.

On June 29, 2021, when we announced that our board of directors authorized a share repurchase program under which the company may purchase up to $1 million of its ADS through December 31, 2021. We plan to start repurchasing following our second-quarter earnings as a show of confidence in our operations going forward. This concludes our prepared remarks for today. Operator, we're now ready to take questions.

Questions & Answers:

Operator

Thank you. We will now begin the question-and-answer session. [Operator instructions] Today's first question comes from Katrina Wong with Tiger Brokers. Please go ahead.

Unknown speaker

OK. Thank you for taking my questions. My first question is would you please elaborate on the performance of your kindergarten business during the second quarter of 2021? 

Patricia Sun -- President

Thank you. I will take this question. Growth for our smart music learning business is very healthy. We added 2,069 collaborating kindergartens to our network during the quarter, achieving over 4,500 by the end of the second quarter compared to 2,500 at the end of the first quarter.

The number of active students during the second quarter of 2021 was 33,000, compared to 5,300 in the second quarter of 2020. And we have expanded our job graphic coverage to two 234 cities. For the rest of the year, we will deepen our collaboration with existing kindergartens while we continue to grow the aggregate number of collaborating kindergartens. Thank you.

Unknown speaker

OK, thanks. And I have another question. Does the return policy prevent the company from conducting marketing activities? 

Patricia Sun -- President

The recent policy is aiming to restrict to K-12 academic education business, which have no adverse impact on us. Instead, recent policy changes have been focused on supporting aesthetic education, including music learning`. The state concert of the PRC and the Ministry of Education has issued a series of important guidelines on the effective development and foundational art education as one of the key development areas for quality education in schools. According to the Ministry of Education's interpretation of the relevant guidance documents on art education issued by the State Council in October last year, schools of all levels will need to include music and art lessons by 2022.

At the same time, it is necessary for all schools to improve student evaluation in aesthetic education and to add up as an exempt subject for junior and senior high schools. Going forward, we believe the Ministry of Education will guide local schools to continue improving resources allocation and increasing the coverage of aesthetic education courses. Eventually, aesthetic education will be included in the evaluation system of China's double first-class universities. Thank you.

Unknown speaker

Thanks.

Operator

And our next question today comes from Lex Zhang with Atlantis Investments. Please go ahead management.

Lex Zhang -- Atlantis Investments -- Analyst

Management, thank you for taking my question. I also have two questions. The first one is that the previous reviews also mentioned the recent Chinese government's crackdown and the after-school tutoring for the students. So, what do you say some of the top tier or K-12 peers decided suddenly turn into your fields.

You know, for example, in our arts or music education. How would you predict that competition will be then? That's my first question.

Tony Chan -- Chief Financial Officer

OK. Thank you, Lex. I will take this question. First of all, to the number of music learners as a percentage of the total population, it's only 9% in China, compared to 45%  in other developed countries.

This means that the penetration rate of music learning in China is still very low and there are tremendous opportunities and market space. In terms of the competition, we think we have several advantages. Firstly, by collaborating with Naxos, the world's largest independent classical music content provider. Our patented classical music library has access to over 900 top-tier record companies.

Secondly, we have a significant early music advantage as we establish an R&D team and began developing music learning content since 2019. So, our amount is very high. Finally, we're building a closed-loop classical music ecosystem that enables music content creation, subscription, learning solutions, life events planning, and execution services. Talent shows are much more, which enables us to provide many more services to music lovers.

So I think we are well-prepared for any kind of increased competition. If there would be any going forward. And we're in a definite leading position, we believe. Thanks for the question.

Lex Zhang -- Atlantis Investments -- Analyst

Thank you. My second question is that -- so, we all know this that reason to companies such as Meituan, Alibaba, and quite recently, Tencent Music was investigated, penalized, and fined even for breaking the monopoly law. So, to think that this keeps you awake at night since Kuke's leader is currently in the classical music industry and has the company done anything, taking any actions in terms of weight or cooperating with third-party platforms and their suppliers.

Patricia Sun -- President

I will take this, the second question. Well, Kuke has always believed that exclusivity is not the best solution to becoming a powerful player in the Chinese market. And Kuke has been consistent with its policy to maintain openness reasonable our clients, big or small, as you can easily observe from our list of platforms and suppliers. With the non-exclusive arrangement, the company can utilize multiple channels to enhance brand awareness and artist profiles especially during the promotion market campaigns for the classic music contests and their recordings.

By aiming to become a contributor to a diverse and competitive market, we can position ourselves to have access to a wider variety of business options and to be able to better support our clients and artists in their own -- in the long run. Thank you.

Lex Zhang -- Atlantis Investments -- Analyst

Thanks.

Operator

And our next question today comes from Yuji Fung with RiverCircle. Please go ahead.

Yuji Fung -- RiverCircle Investments -- Analyst

Hello, thanks for taking my question. I guess three questions. My first question is what do we foresee the revenue contribution from three business segments going forward? 

Tony Chan -- Chief Financial Officer

OK. Thank you, Yuji. It's a finance question so I'll take this one. We're expecting the smart music learning systems business to contribute about 50% of our total revenue this year.

Licensing and subscriptions will contribute another 25% of total revenue, and life events will take up the remaining 25%. And we still expect our smart music learning systems business to be our fastest growing business segment going forward. And we will allocate the maturity of our resources into the development of this business segment going forward. Thank you.

Yuji Fung -- RiverCircle Investments -- Analyst

My second question is it seems that our gross profit margin in the second quarter improved a lot. So, is that margin sustainable or how is the gross profit there in the coming third quarter and fourth quarter? 

Tony Chan -- Chief Financial Officer

Thank you, Yuji. I'll take this question again. We are maintaining a prudent and optimistic view on the gross margin -- gross profit margins going forward into Q3 and Q4 because we're expecting further growth in our licensing of subscription-based business, as well as the number of paying students for our kindergarten lessons, that means the smart music learning systems business. So, we're optimistic on the gross margin -- profit margins going forward.

Thank you, Yuji.

Yuji Fung -- RiverCircle Investments -- Analyst

OK. My last question is about your market share, it's about your capex in the second quarter. Is it possible to reduce the capex while we can maintain the revenue growth in the -- going forward?

Tony Chan -- Chief Financial Officer

OK. Thank you. This is a very, very good question. Thank you.

Capital expenditure was around RMB 40 million for Q2 mainly due to the launching of smart piano systems in partnering kindergartens. We have been looking into ways to increase the number of paying users while tightening control of our capex. One possibility is to allocate additional resources into existing kindergartens to help them increase students enrollment for our Kukey courses. This would definitely achieve the purpose of growing paid users without additional capex, but it would compromise our ability to grow our network of partnering kindergartens.

So, we are evaluating this option and we are also evaluating other options and at the moment. Thank you.

Yuji Fung -- RiverCircle Investments -- Analyst

OK. Thank you.

Operator

Ladies and gentlemen this concludes our question-and-answer session. I would like to turn the conference back over to our management for final remarks.

Jane Zuo -- Investor Relations Director

Thank you again for joining our call. We look forward to speaking with you in our next earnings call. Have a good day. Bye, bye.

Operator

[Operator signoff]

Duration: 41 minutes

Call participants:

Jane Zuo -- Investor Relations Director

He Yu -- Founder, Chairman, and Chief Executive Officer

Patricia Sun -- President

Tony Chan -- Chief Financial Officer

Unknown speaker

Lex Zhang -- Atlantis Investments -- Analyst

Yuji Fung -- RiverCircle Investments -- Analyst

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