Kuke Music Holding Limited American Depositary Shares (each representing ten (10) Class A Ordinary Shares)

Good morning and good evening, ladies and gentlemen. Thank you and welcome to KUKA Music Holding Limited's fourth quarter 2020 earnings conference call. At this time, all participants are in a listen-only mode. We will be hosting a question and answer session after management's prepared remarks. I will now turn the call over to the first speaker today, Ms. Claire Choi, PR Director, and I are of KUKA Music Holding Limited. Please go ahead, ma'am.

Thank you. Hello, everyone. Welcome to our fourth quarter 2020 earnings call. Thanks for joining us today. On the call with me today, there are Mr. Yu He, KUKA's founder, chairman, and CEO, and Ms. Sun, the president of KUKA Music, Mr. Tony Chan, the CFO of KUKA Music, Mr. Yu and Ms. Sun will give a general overview, and then Tony will discuss the financials. Following the prepared remarks, our team will be available to answer your questions. You can refer to our fourth quarter 2020 financial results on our IR website at ir.kuke.com. You can also track a replay of this call when it becomes available in a few hours on our IR website. Before we start, please note that this call may contain forward-looking statements made pursuant to the Safe Harbor Prohibition for the Private Securities Legitimacy 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 achievement of the company to be material difference from the results performance or expectations implied by this forward-looking statement. All forward-looking statements are expressly qualified in their entirely by the cautionary statement, risk factors, and details of the company's filing with the SEC. The company undertakes no duty to revise or update any forward-looking statement for selected events or circumstances. after the date of this conference call. As a reminder, this conference will be recorded. In addition, a live and archived webcast of conference call will be available on KUKA Investor Relations website at ir.kuke.com. It's now my pleasure to introduce our first speaker, Mr. Yu.

Thank you, Claire. Good morning and good evening, everyone. Welcome to our first-ever earnings call as a listed company. First, I would like to thank our investors for all of the outstanding support you have given to our company. For most companies, 2020 was not an easy year. However, since the second half of 2020, China's economy has largely recovered from COVID-19. By the fourth quarter of 2020, our operations had also largely recovered, especially compared with the first three quarters of the year. This improvement was mainly driven by two trends. First, was the overall rebound of economic activities in China. Second, was the resumption of our customers' business operations. In September, for example, as most of China's Kingdoms Garden reopened, our music education business entered into a new growth cycle. And we have observed a strong demand for our music education services since then. As a leading provider of smart music education solutions in China, we expect our kindergarten segment to continue to perform well going forward. We also benefited from the stability and the loyalty of our licensing and subscription customer base. In the fourth quarter, The majority of our customers from this segment renewed their service contracts with us. And more and more traditional businesses are going online and into the digital world. These companies will need music solutions to improve their customer experiences. Next, I will pass to Patricia Sun, president of Cook Music. who will introduce our business segment highlights.

Thank you, Mr. Yu. Good morning and good evening to everyone. As this is our first earnings call, I would like to take this opportunity to elaborate on some of the key areas for each of our three business segments. As a leading provider of smart music education services in China, we are backed by a well-diversified classical music library and a rich collection of digital music scores, both of which have been key elements to securing our leading position in the offering of pioneering interactive music classes with performance tracking. A lack of qualified music teachers and high tuition fees for music education have been the main industry pain points in China. Recognizing these concerns, we have developed a system that can independently teach students, thereby reducing the role of human teachers to that of maintaining an orderly classroom. Going forward, we will continue utilizing and upgrading this system to make high quality music education affordable and accessible. Affordable and accessible. There are about 280,000 kindergartens and more than 47 million students. Since launching our smart music education solution in late 2019, the demand from kindergartens has been quite robust despite the impact of the COVID-19 pandemic. In the fourth quarter of 2020, we once again observed the resilience of our target markets. As of December 31, 2020, our collaborating kindergarten had grown to more than 1,600 from 248 a year ago. Our student enrollment had increased to more than 30,000 from 5,600 a year ago. and our geographic coverage has expanded to 172 cities by year-end. As mentioned, growth in these segments is also being driven by favorable government policy. At the end of 2020, for example, the Ministry of Education officially announced that it plans to raise the importance of physical education art education, and music education, and may include these subjects in both high school entrance examinations and high school academic proficiency tests in most cities in China as soon as 2022. Recognizing these favorable signals and the demand for our solutions, we expect our music education business to deliver strong results in 2021 as we continue to expand at a rapid pace. Overall performance for this segment is generally subjected to seasonal fluctuations and the change in school terms. Now turning to our licensing and subscription service and business, we pride ourselves as the hub to one of the most abandoned pools of classical music content in China Our extensive catalog of copyrighted content allows us to explore various business opportunities, establish unique competitive advantages, and attract clients that are key players in their field, including, among others, major digital music service providers, publishing houses, public libraries, movie and TV production companies, airline companies, and high-end stereo equipment manufacturers. By maintaining long-lasting relationships with these clients, we are able to maintain stable revenue projections with solid growth potential. In addition, our ability to utilize our capital can also fuel the development of our music education segment, and these two growing segments have become increasingly correlated. Our live classical music events business also has strong revenue growth potential. In February 2020, we acquired BMF, which has been involved in hosting the Beijing Music Festival, one of the most influential classical music events in China for the past 23 years. As a result of the acquisition, our music ecosystem now encompasses music content, smart education solutions, and performing arts. In October 2020, we successfully hosted the 23rd Beijing Music Festival through a combination of online and offline music programs. By addressing the full breadth of people's music needs, we believe that our comprehensive music ecosystem will become an essential part of people's daily lives. For research and development, we will continue to upgrade our smart music education system and curriculum. We will also introduce more innovative technologies and product lines such as online master classes, virtual workshops, and high resolution music audio collections across the music education market for students in K-12 and above. Our goal is to cultivate a music ecosystem through which individuals can progress from their earliest stage of development to the professional level. We remain confident that our unique business model, our differentiated advantages, and the favorable market environment in which we are operating will allow us to maintain our growth in 2021 and beyond. With that, I will pass the call over to our CFO, Tony, who will walk you through our financial details for the quarter. Thank you.

Okay. Thank you, Patricia, and hello, everyone. This is Tony Chen, CFO of KUKA Music. Before we start our detailed financial discussion, please note that we will be presenting non-IFRS measures along with IFRS measures today. Our non-IFRS results exclude certain non-cash expenses, and we believe such non-IFRS measures can help management better understand the trends in our business development. The details of these expenses can be found in the reconciliation tables included in our press release. Please note that unless otherwise stated, all the financial numbers we're presenting today are for the fourth quarter of 2020 and are in Renminbi terms and that percentage changes on a year-over-year basis. Okay, going to our numbers, revenue in the quarter increased by 21.7% to $128 million from $105.2 million a year ago This increase was mainly driven by the increase in revenue from our smart music education services, which was mainly due to our increasing brand awareness in music education, higher kindergarten subscription growth, and the announcement of new government policies in favor of music education, as well as the increase in revenue from our newly acquired live classical music event business. That is BMF that Patricia just mentioned. Such improvements were partially offset by a decrease in licensing and subscription revenue, which I will put some additional color on in just a moment. Excluding the impact resulting from the consolidation of BMF's revenue, our total revenue in the quarter was $96.5 million. representing a year-over-year decrease of 8.3%. Now turning to our revenue breakdown. In China, the overall music industry was somewhat impacted by the pandemic in 2020, just like other industries. Such unfavorable conditions restricted our ability to secure new customer contracts particularly in the first half of the year, which led to suboptimal results for our recognized revenue in the Floss quarter. As such, revenue from licensing and subscription in the quarter was $46.4 million compared to $52 million a year ago. Nevertheless, revenue from our smart music education business in the quarter increased by 2.5% to 54.5 million from 53.2 million in the same period of 2019. Such results were largely driven by the significant growth of our smart music education subscription business, which accounted for 42.6% of our total revenue in the quarter, showcasing our quick recovery from the negative impacts of the pandemic. Finally, due to the gradual resumption of offline music performances across the country, as well as our success in hosting the 23rd Beijing Music Festival, we generated $27.1 million in revenue from live classical music events. Total cost of sales in the quarter increased by 36.6% to $26 million, This increase was mainly due to our expansion of smart music subscription partnerships with Kindergarten, as well as the consolidation of EMF into our financial results. Gross profit in the quarter was $102 million, representing an increase of 18.4%. Gross margin was 79.7%, compared to 81.9 percent in the same period of 2019. Operating expenses were $49.7 million compared to $16.1 million in the same period of 2019. Selling and distribution expenses were $8.8 million compared to $6.9 million in the same period of 2019. mostly due to the increase in promotional activities for the 23rd Beijing Music Festival, as well as the increase in overall advertising service fees. Meanwhile, administrative expenses were 23.3% compared to 8.9 million, sorry, 23.3 million compared to 8.9 million in the same period of 2019. mainly due to the increase in professional fees related to our IPO, which was mainly conducted in the later part of last year. Increase in share-based compensation expenses and the consolidation of PMF into our financial results. During the fourth quarter, as a result of the pandemic and the corresponding increase in trade residuals levels, Our net impairment losses on financial assets were $17.6 million compared to $0.3 million in the same period of 2019. Operating profit in the fourth quarter was $55.8 million compared to $70.1 million in the same period of 2019, while operating margin was $43.6 million compared to 66.6, sorry, operating margin was 43.6% compared to 66.6% in the same period of 2019. At the same time, our net profit for the period was 44.2 million compared to 57.5 million in the same period of 2019. And on IFRS profit was $84.5 million compared to $59.4 million in the same period of 2019. Basic and diluted earnings per share were $1.80 and $1.79 respectively. Basic and diluted non-IFRS earnings per share were $3.5 and 3.41 respectively. Moving on to our balance sheet and liquidity, as of December 31, 2020, we had a total of 25.7 million RMB in cash and cash equivalents. As we mentioned earlier, earlier this year, we have completed an IPO exercise on the New York Stock Exchange, and we have raised $15 million from our IPO. Looking ahead, in order to further improve the effectiveness of our collection process for receivables, we plan to strengthen our payment collection terms and maintain closed dialogues. with our customers regarding their pay schedules to outstanding receivables. Moreover, we expect that our margin will continue to improve as we further expand our school and kindergarten partnerships, promote our smart music education services, and manage the related procurement costs. As customers' demand for quality music solutions continues to grow, we firmly believe that our ability to keep pace with these demands and deliver first-rate music products and services will not only drive our business growth, but also improve our financial performance over the long term. This concludes our prepared remarks for today, and operator, we are now ready to take questions.

Thank you, sir. We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you'd like to withdraw your question, please press star then two. Again, if you'd like to ask a question, it is star then one on a telephone keypad. At this time, we'll just pause momentarily to assemble our roster. And the first question we have will come from Vitus Loan of Deutsche Bank. Please go ahead.

Hi. Can you hear me? Yes, sir. Okay. Okay, you can hear me then. Thanks. Thanks, management, for taking my call on my question. So I'm just wondering, can we get more color in terms of the growth in the education business in 2021? We understand there's a recovery in fourth quarter in the smart education segment. So can management give us more color in terms of the growth, the prospect in smart education business in 2021? Thank you.

Okay. Operator, this is Tony. I'll take the call. Sorry, I'll take the question.

Oh, yes.

Thank you. For the smart music education business segment, we are quite optimistic for 2021. We believe there will be a considerable amount of growth in the number of collaborating kindergartens. And and the number of enrolling students and the overall revenue for this segment in 2021. It may be too early to say specifically just how the growth trend will look like here in the 2020 Q4 results release, but we shall be providing you with more information during our 2021 Q1 first quarter results release that will be coming out soon this year. But here I would like to take the opportunity to explain to you that our main focus for this segment will be on the kindergarten's market. And it has a distinctive seasonality pattern. Due to this seasonality pattern, our growth will not be even throughout the year. The kindergartens in China usually have two school semesters each year. The first one from September to December and the other one mainly from March to June. So in the first quarter, there are the winter holiday and Chinese New Year holiday, which is the most important holiday season for Chinese. So throughout the first quarter, things will usually be quite slow. And so business in this quarter is usually relatively flat. In the third quarter, there are usually the long summer holidays. So again, business will be relatively flat as well. As such, we usually conduct more marketing activities in the second quarter and the fourth quarter because kindergartens are more productive during these two quarters. And therefore, the business results for this segment, the smart music education segment, for these two quarters, namely the second quarter and the fourth quarter, are usually relatively better. But all year round, we do continuously improve on our service and product qualities so as to provide our customers with ever-improving learning experience. So the trend of our performance will not be homogeneous throughout the year. There will be seasonality. Having said that, we are We're considering working with our collaborating kindergartens to open summer classes for kids during summer holidays this year. We hope we can somewhat improve the Q3 performance a bit as compared to the Q2 and Q4. It will be interesting to see how the results will come out this year. This is one example of our marketing team constantly exploring new ways to deliver our education services and attract more students to enroll into our classes. That's pretty much all that I would like to address.

Next, we have Yuji Feng of SBI China Capital. Hello. Can you hear me?

Hello.

Yes, sir, we can hear you.

Okay, okay. Okay, thank you for taking my question. I have two questions. My first question is, as we observe the smart education business is growing, so we assume that our capital expenditure for this segment will be also increasing, right? Does the company take any action or how does the company manage to control the cost effectively for the upstream supplier for this segment? That's the first question. And my second question is, I'm also aware that recently the capital market has raised attention on the education companies due to the changes in policy and regulation in China. How do we foresee these changes in policy? Would they have any impact on our education business going on? Yes, that's my question. Thank you.

Okay. Maybe I'll address the first question, and then Patricia can address the second one. Would that be okay?

Yes, I will take the second one. Tony will take the first one. Please, Tony.

Okay. So let me start with the first question about CAPEX for this year and our control over our supplies and costs. It's a very important question that you've raised. In our smart music education business segment, CapEx do grow simultaneously with the number of collaborating kindergartens. Since we are placing a fixed number of smart pianos into every collaborating kindergarten up front, Along with the growth in the business size, we are expecting a bigger CapEx along the way. So this year, yes, the CapEx we're expecting considerable growth as compared to last year. So currently we have two major manufacturing partners for our smart pianos. And we are already one of the major customers for these two. According to our business plan this year, we will be purchasing of considerably more smart pianos to cater for the large number of collaborating kindergartens to sign up for our services. So we believe we'll be becoming even more important to our manufacturing partners this year. But having said that, we are also evaluating a few other potential manufacturing partners. we might choose one more this year. That means we are targeting to have probably three manufacturing partners this year, and we shall allocate our purchase orders to these manufacturing partners according to their production capabilities, qualities, and their expertise in manufacturing. We would like to specialize them in manufacturing different smart pianos for different market applications for us going forward. We believe we have built a very close and mutually beneficial relationship with our existing manufacturing partners, which will help us in a lot of ways as our business continues to expand in the future. In terms of cost control, this year we're targeting to further improve the design and specifications of our smart pianos. and we shall select the most suitable manufacturing partner to try to further reduce the overall cost of smart pianos in the second half of this year. It will be an important step for us to keep our capex in control this year and beyond. We are all very excited and eager to see how this new development will come out. Overall, I think as our operations grow bigger, we shall be enjoying more economies of scale. And our bargaining power towards our manufacturing partners will grow even stronger. And at the same time, we're constantly improving our product designs and technologies. So we are always trying to add more functions while reducing the overall cost for our system. All these factors will be beneficial to us in terms of the control over our manufacturing partners and costs as our smart business segment continues to grow in size. So that is all that I would like to address for this question. And maybe I'll pass the second question to Patricia.

Okay, thank you, Tony. In order to refresh the second question, could you please ask the question again so we could memorize the question, which is the details of the question. Thank you.

Hello, can you hear me?

Yes. Hello. Hi, yes, hi.

Okay, my first question is that My question is that recently the capital market has raised the tension on the education companies due to the changes in policy and regulation in China. How we foresee these changes? Will that have any impact on our music education business going on?

Thank you. Very clear. As we mentioned in our presentation, The Minister of Education recently officially announced that they plan to raise the importance of physical education, art education and music education, which means that music education may include into the major subjects in both high school entrance examinations and high school academic proficient tests. in most of cities, and maybe the earliest time is in 2022. And we think this is a very good signal for the whole music industry and the music education industry in China. And the announcement made by the MOE urging the necessity to include music education maybe to be the mandatory curriculum at schools, has certainly given us a confidence boost for our current planning for the future development of our smart piano system, which means maybe some companies in the music education industry and market they cannot do the major subjects for the students. But for youth education for our company, we could plan and boost our future, the picture and landscape. And that policy not only meant the future policy might be in favor for our business and likely to pave the smooth way for future plans, but also indicates that the company's plan and the concept is in line with that of the government in the long run. Although we are left with the governmental policies at the moment, but it's still going to take some time for the policy to be rolled out in full. with a solid execution plan from top to bottom. In general, we are optimistic about the future prospects of the announcement and will definitely keep a close eye on its development. But for the moment, we tend to remain cautious to put forward any drastic action plan soon. Thank you.

Thank you, ma'am. Again, as a reminder, if you'd like to participate in today's Q&A, please press star then one on a touchstone phone. Again, that is star then one to ask a question. The next question we have will come from Tony Wang of Tiger Brokers. Please go ahead. Hi.

Thank you for taking my question. And we understand that company is experienced and excel in doing music licensing and a security business for many years. And we noticed that the company started focus on music education business in recent years. And my question is, how does the company apply its content to the music education market? And how does it correlate it to a music education business? Thank you.

Thank you. I will take this question. We have been increasing our attention in first quarter on acquiring and digging into our existing catalog for content that's suitable for music education purpose. Because in our large and diversified content pool, not only we have audio tracks, long form video tracks, but also there are so many and lots of educational content such as music scores and educational e-books and applications. So I will give some examples for what we have done in fourth quarter. For example, the first example is we have my first series and books and educational content. And this series and books have always been a long-term path to selling books for kids, not only in China market, but also in the global market. And recently we have digitized and localized my first piano book. And we developed into the digital asset, and we utilize our platform and social media channels to add users like parents and kids who are learning our Cookie Smart Piano and add their additional education materials. And also we have so many latest publications that developed by Nexus UK which they licensed us. And also we would like to integrating the content of these My First Series books and educational content into our cookie courses and our teaching systems. Secondly, another fascinating product is Music Box, initially designed as an interactive music education platform for students from K-12 and above. As well as this music box is also for the guardians and teachers, etc. In the fourth quarter, in addition to translate the platform and music box contents in Chinese for the local market, we have produced audio programs which the contents from this music box platforms and contents and also based on content of Musicbox. And we are now, this content, AudioPreps, are now available to users through our distribution with local digital service partners. And the third one is, in fourth quarter, we are focusing on acquiring some educational content with our partners, like master class module. For example, we acquired from two of the most influential master class content providers. One is Saka, which is based in Spain, and they have, they keep very good relationship with the world famous conservatories, and they have so many professional teachers, professors, and soloists, and artists. And also another one is a classical academy. We just signed a contract with them about the month-class accountants' supplies, which they provide students with courses from what class soloists conduct. And they have violin classes, math classes, cello, piano, and also conducting and all the aspects from professional classical music areas. and also all cross-instrument segments. While pandemic has temporary but international travel on our hearts currently, we think that our Masterclass series we've acquired recently will allow the students to be able to learn from the best without leaving their spots. And now the Masterclass we've acquired from these two famous providers available on our platform. If you go to the KUKA.com, you could see that we have some master class videos on the platform. And that will not only help the KUKA students to attract KUKA students to the backup of our so famous and rich master class content, but also that there has been a benefit for our future to develop our courses for K-12 students and above. And we could see that we have formed a strategic alliance with local publishing houses recently to strengthen and further secure sufficient resources in sheet music for KUKI students because score sheet in the cookie system and teaching system is very important and very important content resources for the students who are learning our courses and we have been started and we have been starting and collaborating with not only with local public houses but also with international public houses to enrich our score sheets Thank you. That's it. That is my answer.

Again, if you'd like to ask a question, please press star, then 1 on the telephone keypad. If you're using a speakerphone, again, please pick up your handset before pressing the keys. Again, that is star, then 1 to ask a question. Again, we will just pause momentarily to assemble our roster. The next question we have will come from Brian Lee of AMTD. Please go ahead.

Hello. Thank you for taking my question. I have one question regarding your smart music education business. So we want to know what strategy will the company take to develop the market to grow the business? And will there be any other collaboration on the smart educating business besides collaborating with the kindergartners? Thanks.

Okay, operator, maybe I'll take this question.

Oh, yes, sir. Please go ahead.

Okay, about the marketing plan and if there are other forms of business collaboration. This year, our main focus for the smart music education business segment this will be the kindergarten market because we believe the market potential is huge there. There are currently over 280,000 kindergarten in China. There are over 47 million students. So this is no doubt a hugely important market for us to tap into and keep developing. Our goal is to occupy a significant market share in music education in this market in a few years' time. Within a few years' time, it will be a gradual process. So to achieve our target growth rate, we are expanding our marketing team and our distributors network. We're increasing the number of distributors significantly this year At the same time, we're adding more high-quality courses into our system to further enrich our content offerings. With these measures, we believe the number of collaborating kindergartens and number of enrolled students will grow significantly this year. In terms of the geographical coverage, we will continue to target densely populated cities with lots of kindergartens as our primary service coverage area. It will be more efficient delivering our services in such areas. So we do need a lot of resources to achieve these ambitious targets. A major part of the company's resources will be applied towards the development of this market segment. And with kindergarten as the main focus, we are also trying out new forms of business collaboration, such as community stores that will be providing piano classes to people in different communities. We are still in experiment phase and collecting useful data to evaluate the feasibility of such kind of business model. But again, we would like to make it very clear that our main focus will be the kindergarten market going forward. That's pretty much what I would like to address with this question.

Very clear. Thank you.

Thank you.

Well, at this time, we're showing no further questions. We'll go ahead and conclude today's question and answer session. I would now like to turn the conference call back over to the management team for any closing remarks. Ladies and gentlemen.

Thank you again for joining our call. If you have any questions, please feel free to contact us or request through our website through email at kuka at icrinc.com. We're looking forward to speaking with you everyone next quarter. Have a good day.

And we thank you, ma'am, also, and to the rest of the management team for your time also today. Again, the conference call is now concluded. At this time, you may disconnect your lines. Thank you, everyone. Take care, and have a great day.