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

Good morning and good evening, ladies and gentlemen. Welcome to KUKA Music Holding Limited Second Quarter 2021 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. Please note, today's event is being recorded. I will now turn the call over to the first speaker today, Ms. Jane Zhu, with Investor Relations Director of KUKA Music Holding Limited. Please go ahead, ma'am.

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, president, and Mr. Tony Chen, CFO of KUKA Music. Mr. Yu and Ms. Sun will review our business operations first, and then Tony will discuss our financial details. Afterwards... 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 provisions for the Private Security Statistication 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 result performance or expectations implied by those forward-looking segments. All forward-looking segments are expressively qualified in their entirety by the cautionary segment, risk factors, and the health of the company's filing with the SEC. The company undertakes no duty to revise or update any forward-looking statements for selective events or circumstances after the date of this conference call. As a reminder, this conference call is being recorded. In addition, a live and archived webcast of this conference call will be available on KUKO Investor Relations' website at ir.kuko.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, and CEO of KUKA Music.

Thank you, Jin. 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 classical 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 formality, giving it much stronger lasting value. Classical music is the foundation of music learning. In addition, classical music as an art subject promotes strong logical thinking. Musical concepts of rhythm and harmony are closely tied to math, 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, Yuan Longping and Li Siguang, 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 to and learn classical music. Recently, several government policies changed have been focused on enhancing art learning. The State Council of the PRC and the Ministry of Education have issued a series of important guidelines on development and the 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 music and arts lessons by 2022. At the same time, it is necessary for all schools to improve student evaluation in art learning and to add arts as an exam subject for junior and senior high schools. Many provinces, including Hunan, Jiangsu, Yunnan, and Henan, 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 local schools to continue improving resource allocation and increasing the coverage of art learning courses. Eventually, we believe that art 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 the best stage of development to absorb art learning. According to the Ministry of Education of the PRC, In 2020, there were 537,100 schools and 289 million students nationwide. Among them, 291,700 were kindergartens with roughly 48 million children enrolled, 18,800 were primary and secondary schools with 156 million students enrolled. As a leading classical music content provider in China, we support and follow national policy guidance to promote the development of a 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 Nuxos. We have also developed the Kuki smart piano, digital music learning content, and an associated SaaS system. On July 23rd, we announced a strategic cooperation agreement with People's Music Publishing House. The two parties will work together to establish the People's Music and Naxos Global Platinum Record Program of China and a global resource core 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 orchestra, chamber, vocal, and national orchestra music from young Chinese composers and performers 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 advantage to establish a high-quality editorial team to launch interdisciplinary courses that enhance music literacy. 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 explore music services based on students' needs, empowering them with technologies to improve both the student and the teacher experience, while improving the quality and the efficiency of the music lessons. We are confident That's our visionary business strategy, which focuses on music rather than the traditional academic subjects, and in-school learning rather than after-school lessons. Along with the support of the government's policies, we'll continue to feel our development going forward. Our director, Yu Long, one of the most influential conductors in Chinese classical music. One 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 cultural exchange. On July 27th, we announced the programs and theme for the 24th Beijing Music Festival 2021 marked the anniversary year since the passing of many great composers, including Igor Stravinsky, Camille Saint-Saëns, Astor Piazzolla, Gustav Mahler, and Dean Chandler, 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 Lei Ji, the famous guqin player, Wu Ying, the president of the Chinese Music Acceleration Piano Society, and a professor of the Central Consortium of Music. The program included seven different performances. categories including keyboard, orchestral music, and percussion. Musicians and artists ranging from kindergarten students to young adults, from art groups and universities were all welcome to join. This program provides as a great platform to present high quality artwork connect young people from all across the country through art, and promote the sound development of a quality Chinese art training. Next, I will pass it over to our president of Cook Music, Patricia, to provide more insights across our business segments. Thank you.

Thank you, Mr. Yu. Good morning and good evening, everyone. Our second quarter results were characterized by a robust recovery in business, stellar revenue growth, and improved profit margins. We experienced notable growth in all three business segments. Our licensing and subscription revenue in the second quarter reached 39.6 million RMB, 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 continued to expand our library of audio, video, and online masterclass content, effectively attracting more customers to purchasing our content licenses. Our audio and video classic music catalog added more than 80,000 music tracks, reaching more than 2.7 million pieces of content in total, which 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 various types of musical instruments, but also music from multiple countries and regions. The types of musical instruments featured in our music catalog has increased from 2000 at the end of 2020 to 2077 at June 30, 2021. Newly added instruments include unique instruments such as the alto flute and the barabas. The countries and regions 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 and playlists based on different needs of each collaborating platform, utilizing the preferences of listeners from different age groups. Moreover, we cooperated with artists to produce interviews and video content to increase their exposure on streaming platforms. Through continued refinement of operations and product iterations, the number of downloads, clicks, and shares for our music content on cooperative digital service platforms have further improved. For example, in April, we worked with our collaborative platforms to promote our recording artists who joined the International Center for the Performing Arts Orchestra's six-city nationwide tour in order to promote the sales of its digital albums and related content. Late in June, we launched a one-month online event to promote the recording works of Chinese artists and enhance the interaction between artists and the listeners. During the second quarter, we introduced KUKA Music Box Classical Music Learning Guide, an audio product based on the Chinese Naxos Music Box product. Going forward, KUKA 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 delicacy of music, improve musical tastes, and introduce greater enjoyment in listening to classic music. As a result of expansion of our music offerings, our library subscribers have also increased. In the second quarter, we signed contracts with five new public libraries. By the end of the second quarter, we had 775 universities and library customers. In terms of our smart music learning solutions business, revenue in the second quarter reached 20.6 million RMB, 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 cookie AI courses have successfully centralized and digitalized the music learning process, which previously was highly individual and plagued by inconstant quality. By utilizing AI technology and a cloud infrastructure, we are able to digitalize traditional teaching tools into our SaaS system. while storing content updates and data in the cloud for further refinement and data analysis. Each of our smart pianos serves as an intelligent terminal which 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 cost barriers that students and their families face when trying to learn piano. Kupi's online group, Interactive Cordis, removed the need for private piano rooms, eliminating the expensive cost of renting space. For students, tuition costs are further reduced as teachers only need to supervise students during class. Families no longer need to purchase a piano, pay a transportation cost to attend classes, or commit time investment for commutes to attend lessons. With a well-rounded music learning in mind, KUKA 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 cookie 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 catalog which contains classic music, audio books, and children's songs. For our music event segment, revenue in the second quarter reached 23.8 million RMB, 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 industry partners. In light of increasing demand in the music industry and the recovery of the market economy in the post-epidemic 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 public gathering restrictions, and actively explore new business initiatives to increase our business synergies and form a closed-loop industrial chain. 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. Tony.

Okay. Thank you, Patricia. Yeah. Thank you, Patricia. And hello, everyone. Before we start our detailed financial discussion, please note that we will present non-IFRS measures today. Our non-IFRS results exclude certain non-cash 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, all financial numbers we present today are for the second quarter of 2021. and are in RMB terms. All comparisons are 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. Our 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 reflected a recovery in demand for music streaming by institutional subscribers, supported by increases in the company's music content offerings. Revenue from music event 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 their 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 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 non-RFI profit per ADS were both 0.62. Moving on to our balance sheet and liquidity, as of June 30, 2021, we had a total of 153.3 million RMB in cash and cash equivalents. We are on track to achieve our full-year revenue target of not less than 400 million RMB, and we expect our business activities to continue improving for the next two quarters. On June 29th, 2021, we announced that our board of directors authorized a share repurchase program under which the company may purchase up to 1 million US of ADS through December 31st, 2021. We plan to start repurchases following our second quarter earnings as a show of confidence in our operations going forward. This concludes our prepared remarks for today. Operator, we are now ready to take questions.

Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on a touch-tone phone. To remove yourself from queue, please press star then two. Today's first question comes from Cartina Wong with Tiger Brokers. Please go ahead.

Okay. Thank you for taking that question. And my first question is, could you please elaborate the performance of your kindergarten business during the second quarter of 2021?

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 quarter, achieving over 4,500 by the end of 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 geographic coverage to 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.

Okay, thanks. And I have another question. Does the recent policy prevent companies from conducting marketing activities?

The recent policy is aiming to restrict the K-12 academic education business, which has no adverse impact on us. Instead, recent policy changes have been focused on supporting aesthetic education, including music learning. The State Council of the PRC and the Ministry of Education have issued a series of important guidelines on aesthetic development and foundational arts 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 document on arts education issued by the State Council in October last year, Schools of all levels will need to include music and arts lessons by 2022. At the same time, it is necessary for all schools to improve students' evaluation in aesthetic education and to add arts as an exam 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 authentic education courses. Eventually, authentic education will be included in the evaluation system of China's double first-class universities. Thank you.

Thanks. And our next question today comes from Lex Zhang with Atlantic Investments. Please go ahead.

Hi, management. Thank you for your presentation. I have also two questions. The first one, is that the previous lady also mentioned the recent Chinese government's crackdown and the after-school tutoring for the students. So what if, say, some of the 12K or K-12 peers decided to suddenly turn into your fields, you know, for example, inner arts or music education, how would you predict the competition will be? then that's my first question.

Okay, thank you, Lex. I will take this question. First of all, the total number of music learners as a percentage of total population is only 9% in China compared to 45% in other countries. This means that the penetration rate of music learning in China is still very low. and there are tremendous opportunities in market space. In terms of the competition, we think we have several advantages. Firstly, by collaborating with Nexos, 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 movement advantage as we established an R&D team and began developing music learning content since 2019. So our market is very high. Finally, we're building a closed-loop classical music ecosystem that enables music content creation. Subscription learning solutions lies against 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 are in a definite leading position, we believe. Thanks for the question.

Thank you. And my second question is that, so we all noticed that recently, companies such as Meituan, Alibaba, and quite recently, Tensa Music were investigated, penalized, and fined even for breaking the monopoly law. So does this keep you awake at night since KUKA is a leader currently in the classical music industry? And has the company done anything, taken any actions in terms of the way to cooperate with your third party platforms and your suppliers?

I will take this, the second question. Well, KUKA has always believed that the exclusivity is not the best solution to becoming a powerful player in the Chinese market. And Google has been consistent with its policy to maintain the openness with all our clients, big or small, as you can easily observe from our list of platforms and suppliers. With a 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 artists 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 be able to better support our clients and artists in the long run. Thank you.

Thanks. And our next question today comes from Yuji Fung with River Circle. Please go ahead.

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

Okay. 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 live events will pick 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 majority of our resources into the development of this business segment going forward. Thank you.

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

Thank you, Yuqi. I'll take this question again. We are maintaining a prudent and optimistic view on the growth margin, growth profit margins going forward into Q3 and Q4 because we're expecting further growth in our licensing and subscription 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 profit margins going forward. Thank you, Eugene. Okay.

My last question is, would you mind to share a bit about the cap tax in St. Quartier? Is it possible to reduce the cap tax while we can maintain the revenue growth going forward?

Okay, thank you. This is a very, very good question. Thank you. Capital expenditure was around 40 million renminbi for QQ, mainly due to the launching of smart piano systems and partnering kindergartens. We have been looking into ways to increase the number of ping users while tightening the control of our capex. One possibility is to allocate additional resources into existing kindergartens to help them increase student enrollment for our cookie 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 at the moment. Thank you.

Okay, thank you.

And, 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.

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

Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines.