Cheetah Mobile Inc. (CMCM) Q1 2016 Earnings Report, Transcript and Summary

Welcome to Cheetah Mobile First Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today’s presentation there will an opportunity to ask questions. [Operator Instructions]. Please note this conference is being recorded. I would now like to turn the conference over to Helen Jing Zhu, IR Director. Please go ahead.

Thank you, operator. Welcome to Cheetah Mobile’s first quarter earnings conference call. With us today are Mr. Fu Sheng, our CEO and Mr. Andy Yeung, our CFO. Following management’s prepared remarks we will conduct a Q&A session. Before we begin, I refer you to the Safe Harbor Statements in our earnings release, which also applies to our conference call today, as we will make forward-looking statements. At this time, I would now like to turn the conference call over to our CEO, Mr. Fu Sheng. Please go ahead, Fu Sheng.

We have begun 2016 on a solid note with revenues coming in at the high-end of our guidance. But, we have to admit that we were too optimistic when we made our full year 2016 guidance. At that time we saw a quarter-to-quarter decline in first quarter would simply be seasonality but this change would get better in the second quarter. However revenues have not grown as anticipated in the early part of the second quarter. As a result, we expect our revenue and profit for the full year 2016 to be lower than what we have initially planned. Three key factors contributed the weakness in our expected mobile advertising revenues growth, which is a key driver of our overall growth. First, decline in eCPMs from some of our third-party advertising platform partners in the international markets; second, slower than expected progress in building our effective direct sales force; and third, longer than expected time for us to execute our content strategy. We are thinking a series of measures to grow our revenues in the near term. For example, we have enhanced product promotion in key developed markets, in addition, our newly acquired mobile games, Rolling Sky further expands our casual game offerings, to adjust long term [indiscernible] we have begun implementing a two-pronged approach to boost our long-term growth prospects. These efforts include aggressively investing in new content products to increase user engagement, as well as strengthening our direct sales operations. While recognizing the challenges that lay ahead, I am confident that, with focus and determination, we will be able to build a sustainable and profitable business model. We are very confident in Cheetah Mobile’s future, because first of all, look from the overall market, advertisers still have strong demand for global mobile advertising service, especially ecommerce and brands advertisers. And we will remain a fast growing ad format. Secondly, some of our recent launched content product already showed some early encouraging progress. We have a number of content products now in the product pipeline ready to be launched in the coming quarters. Third, during the first quarter, we have adjusted and expanded the direct customers, sales team. This already directly contributed to the re-accelerated growth of our mobile advertising revenue in China in the first quarter. To replicate the successful experience overseas, we recently hired Todd Miller, as a global sales vice president. Todd who was a vice president of Yahoo prior to joining Cheetah, he worked for Yahoo for 13 years in managing much of sales team. We have no doubt that Todd will help expand our overall sales efforts in North America and Europe. In addition, I would like to emphasize that we will continue to invest in data analytics heavily even if we are facing some short term hurdles in becoming a leading global advertising platform. With that in mind, we remain confident that our business strategy is on the right track and we will continue to aggressively execute that strategy managing user acquisition, user engagement, revenue growth and profitability for the long term sustainable growth. With that, I will hand the phone over to our CFO Andy.

Thank you, Sheng. Hello everyone. We continued to grow our user base, revenues and profitability in the quarter, driven by our solid mobile and overseas performance. Before I walk you through the details of our financial performance, I would like to point out that we gained control of Kingsoft Japan on January 29, 2016. As Cheetah Mobile and Kingsoft Japan were under common control by Kingsoft Corporation, both before and after the closing of the combination, in accordance with ASC 805-50, our unaudited financial information mentioned below, unless otherwise stated, has been prepared as if Kingsoft Japan had been controlled by Cheetah Mobile to the preceding -- throughout the periods presented. In addition, all financial numbers are in RMB unless otherwise noted. Total revenue grew by 57% year-over-year to RMB1.12 billion in the first quarter. Excluding the impact of Kingsoft Japan consolidation, total revenue grew by 63% year over year to RMB1.096 billion. This strong performance was again driven by our organic business growth, particularly in mobile and global operations. By platform, mobile revenues grew by 111% year-over-year to RMB827 million for the first quarter. Mobile revenue accounted for 74% of our total revenues in the quarter, up from 55% in the prior year period. In March Cheetah had approximately 651 million mobile monthly active users worldwide, a 47% increase from a year ago. PC revenue declined by 9% year over year in the first quarter. The decreases in PC revenues were mainly due to the migration of internet traffic from PC to mobile in China. By region, overseas revenues were RMB634 million for the quarter, up 116% year-over-year. Overseas revenues accounted for 57% of our total revenues or 77% of our mobile revenues in the quarter, up from 41% total revenues or 75% of mobile revenues in the prior year period. In March, 80% of our mobile monthly active users were from the overseas market compared to 71% in the year ago. China revenue grew by 16% year-over-year in the first quarter, supported by accelerated mobile advertising revenue growth which more than offset PC revenue declines in China. By segment, revenue from online market services were RMB992 million for the quarter, up 70% year-over-year. The increase was driven by our growing mobile user base and increased demand from our advertisers, including third party advertising platforms, for our mobile advertising services worldwide, as well as the monetization of light causal games through in-game advertising. Revenue from IVAS for the first quarter were approximately RMB102 million, an increase of 5% year-over-year. The increase was primarily driven by growth of our mobile game publishing revenues, including the successful monetization of Piano Tiles 2 in the overseas market. Revenue from Internet security services and other for the quarter were approximately RMB20 million, a decrease of 26% year-over-year. The decrease was primarily due to a decline in sales of the company’s air purifier product. Moving to our costs and expenses. SBC expenses for the first quarter were approximately RMB91 million compared to RMB46 million in the same period last year. As we said in the past, we will incur higher SBC expenses this year mainly due to the shares and options granted to management and employees for attracting and retaining top talent particularly in the R&D area. To help facilitate the discussions of the company's operating performance, the following discussion will be on a non-GAAP basis, which excludes stock-based compensation expenses. For financial information presented in accordance with US GAAP, please refer to our press release, which is available on our website. Non-GAAP cost of revenues for the quarter were RMB3219 million, up 97% year-over-year. The increases were primarily due to higher traffic acquisition costs associated with our third party advertising publishing business on the Cheetah Ad Platform, higher bandwidth costs and Internet data center costs associated with increased user traffic worldwide and data analytics. Non-GAAP R&D expenses for the first quarter were RMB167 million, up 38% year-over-year. The increases were primarily due to increased headcount associated with our stepped-up investment data analytics and new product development, especially the development of our new content driven products. At the end of the quarter, we had approximately 1700 R&D personnel. Non-GAAP sales and marketing expenses for the first quarter were RMB438 million, up 75% year-over-year. The increases were primarily due to spending on promotional activities for our mobile business, including the continued global promotion of Piano Tiles 2. As Sheng mentioned, we plan to aggressively expand our direct sales operation in North America and Europe, that may result in higher personnel related selling and marketing expenses. Non-GAAP G&A expenses for the first quarter were RMB88 million, up 33% year-over-year. The increases were mainly due to increased headcount associated with being a publicly listed company and higher staff benefits costs. Non-GAAP operating profit for the first quarter was RMB114 million, an increase of 10% year-over-year. Non-GAAP net income for the first quarter was RMB102 million, an increase of 33% year-over-year. Excluding Kingsoft Japan consolidation impact, non-GAAP net income for the first quarter was RMB102 million, an increase of 32% year over year. Non-GAAP diluted earnings per share ADS for the first quarter increased by 32% year-over-year to RMB0.71 or US$0.11. Adjusted EBITDA for the first quarter was RMB151 million, an increase of 11% year-over-year. Adjusted EBITDA is a non-GAAP measure that is defined as earnings before interest, tax, depreciation, amortization, other non-operating income and share based compensation expenses. Now, let me give you our second quarter revenue guidance. We currently expect and estimate total revenues for the second quarter to be between RMB975 million to RMB1 billion representing a 10% to 13% year-over-year increase. The implied sequential decline was primarily due to lower than expected revenue from some of our third party advertising platform partners in international markets. As Sheng mentioned earlier, Cheetah is facing some short term headwind and some structural issues and we have begun to implement a number of actions and initiatives to accelerate revenue growth. These initiatives involve aggressive investment in new products -- new content products and expanding our direct sales operations, which will result in a short term financial impact on our P&L and may take some time to pay off. However we would like to emphasize that Cheetah Mobile’s operational direction and history have changed several times in today's fast changing mobile world, and we have successfully evolved with it. With that in mind, we're confident that we are on the right track. So again, please note that this forecast reflects the company's current and preliminary view and subject to change. Before we conduct the Q&A session, I would like to remind investors and analysts that on March 16, 2016 the company’s Board of Directors have approved a share repurchase program where the company may purchase its ADS with an aggregate amount up to $100 million over the next 12-month period. The share repurchase plan does not require the company to acquire a specific number of shares. As of May 18, 2016, no ADS was repurchased by the company. The board’s decision reflects our belief that our shares are presently undervalued and demonstrate our confidence in the long term outlook of our business. And this concludes our prepared remarks for today. Operator, we are now ready to take questions.

[Operator Instructions] The first question comes from Wendy Huang of Macquarie.

[Foreign Language] My question is about, now you are resetting the growth expectation for the top line, previously you gave a bottom line guidance. So with the reset of the revenue growth, and how will you actually control the costs and how should we expect the bottom line for this year? Thank you.

Wendy, thank you. This is Andy. I will take this question. So as you mentioned, like we are obviously looking into the second quarter and see lower than – lower growth than we had expected before. So overall for the full year we do expect both the top line and also the bottom line to likely coming below what we have targeted before, for the full year 2016. However as we mentioned before, this year we will continue to try to drive synergy and leverage from our sales and marketing expenditure particularly and if you look at that, we have already beginning to show some results in that. So for the full year we still expect to maintain profitability and we will control and because if you look at the way we actually invest in R&D or in sales and marketing in China, when you look at what we put in there, and how much we can make it return. But probably in both growth rate and also profitability would come in for 2016 significantly below what we have previously targeted at the beginning of the year, just because we wish in terms of how we expect revenue to come in in the second quarter.

Thanks, Andy. Just wanted to clarify, so you just mentioned that you’re still trying to be profitable but I think previously you were targeting not just being profitable but also RMB1 billion non-GAAP net profit.

Right. Obviously if you look at the growth projection in the second quarter, it’s going to be quite a significant haircut in terms of our overall growth expectation right now. So with that significant haircut in growth, it’s unlikely that we will achieve what we have set out to achieve in 2016 unfortunately. And so it would be quite a reduction I think. But we will continue to maintain cost control to make sure that we are profitable and we will try to generate and control costs given the new revenue expectation that we have. And we would adjust our plan if we need to going forward.

But how would 2016 end up being compared to 2015? Last year although you were only guiding like breakeven, that you ended up having like RMB0.5 billion net profit. So even if we are using the new second quarter revenue growth guidance, actually you can still have like 10% to 13% revenue growth. So should we expect that the profit dollar amount to be better than last year still despite of the reset of the growth expectations?

I think if you expect that, I think the profit margin, given that the expectation that we have, and also the cost runway that we have, I think that would probably be little bit too optimistic, but we will try to maintain cost control. And again last year we really out-performed our profitability expectations because, a couple of factors, one of them being that our top line was actually growing faster than we had forecast in 2015. So today, this year, we have the opposite event that is happening right now, and so we probably would not be as aggressive in terms of the profitability forecast. So again right now we have great expectation for our top line. So we would calibrate our expenses as well but it is unlikely we’re going to achieve what we have set out at the beginning of the year, would be significantly lower than that. And when you want the run rate for the second quarter, which I think is quite a bit lower than we have forecast before. So I would not be aggressive in profitability forecast when you have slowing top line growth.

[Foreign Language] So my second question is about one of the reasons you’ve provided for the slower top line growth is actually rare to your partners. So as far as I understand that you are working with those international partners like Facebook as well as the Chinese partners like Tencent, and also, last night Tencent just reported kind of below Street expected advertising revenue growth. So can you provide more color as to what actually -- partners actually has kind of obviously [indiscernible]?

[Foreign Language]

Right. So I think when we look at – first of all, I think when we look – when we mention some lower than expected eCPM from our partners, that’s referring to our international partners, especially in the US. In terms of – what happened in the quarter, we mentioned, if you look at – in the first quarter when we first initially make our 2016 plan, we expect first quarter sequential decline from the fourth quarter. But we mainly believe that was attributed to seasonality, because from operational history, we have seen consistent growth in revenues coming from our third party advertising platform partners. So we expect a seasonal rebound in the second quarter but obviously that did not happen as we have anticipated and in fact, we didn’t see much rebound in April. So as we said now we expect that to be a challenging time for us. But this is not completely out of our expectation. We do expect eventually – or previously we have expected sometime late this year, we may see the third party advertising platform may become as a channel for us, may become frustrated and become a top growth, hence, we have earlier announced our expansion in our direct sales effort in the last quarter. But I think the pace of this happening caught us little surprise, it is a few quarters ahead of our anticipation. But nevertheless if you look at our user base, the user traffic that we have, and then I think once we solve some of this issue and build up our own direct sales force, we should be able to see revenue growth restarting again.

[Operator Instructions] The next question comes from Evan Zhou of Credit Suisse.

[Foreign Language] My question is regarding – some more colors regarding what’s specifically changed in April that we find the algorithm actually changed, that actually kind of impact the numbers in a meaningful way. And so on the read through on some of the leading advertising platform reports in the first quarter, actually some of these have reported pretty good numbers. So is there like a meaningful direction change of the algorithm also of the partner strategy that this platform is planning to do? Any color would be helpful.

[Foreign Language]

Evan Zhou, thanks for your questions. So to be fairly frank with you, in the first quarter our company had a major reorganization. We have reorganized our business line, including our two applications, our content product and our game operation. And during that period of time we made mistake and we did not communicate with our partner as we should have. So that made perhaps the reason why we were caught by a little bit surprise.

[Foreign Language]

Right. Again to be fair and honest with you, we were a little bit too complacent in the first quarter but we see the sequential declines from the fourth quarter to the first quarter. We largely excluded that to seasonality and did not pay as much attention as we should have to the change in the revenue trend. And when we looked at it in April, we realized that and we are still hoping that in the next two months in May and June revenue may recover. Right now it’s not recovering as the way that we like to see it.

[Foreign Language] So if you – when we look at other peers and partners, they seem to have experienced some of the trend, then we need to hone into the issue. And so we’re little bit late for that. In addition to that – when we see – when we actually do the analysis we see there is a significant decline in the eCPMs, so that’s the driver for that. And also, if you look at –

Mr. Yeung, Mr. Fu, are you ready for the next question?

One second. So the strategy is, next two or three quarters to changing our own sales team – revenues.

Right, if you look at our strategy going forward, I think sure we can look back and we have them and announce on what happen from first quarter and into early part of second quarter and try to analyze how it’s happened. And we’re very open to share that with you guys, the reason that – the key reason that we find as the reason for the slowing that significantly and – but we also want to emphasize that we’re also taking few actions immediately and we also have a longer term plan, as we mentioned before, immediately we have – we also capped some of the marketing expenditure, we have strengthened our direct sales force. In fact, we have made some adjustments in China which actually helped us to accelerate growth in the China direct sales business, and we’re also making good progress in terms of building our overseas sales – direct sales team. As we mentioned earlier in the press release as well as in the conference call, we have been very pleased to announce that Todd Miller, who previously worked at Yahoo as VP of regional sales have joined us as our VP of Global Sales. I think Todd would bring a lot of experience and skill to help us to build out and strengthen our direct sales effort in North America and European markets. So – and then also if you look at our content strategy, it also is beginning to bear fruit. We are rolling out new products. We will be more aggressively rolling out new products in the coming quarters, and that should help us to both our user engagement level. So yes, we do admit that we have dropped a ball in terms of – from the first quarter to the second quarter, not noticing the build-up in trend in marketplace. We are taking a lot of actions and we are taking it very seriously. So –

[Foreign Language] Second question is regarding the content driven product, the progress. Could you share some color on how the progress of the development, what’s the kind of launch timeline and – in terms of the increased investments in R&D and also promoting the product, what’s kind of the ballpark number that we will be looking at for the rest of the year and maybe 2017?

[Foreign Language]

Okay. So regarding the timeline for our content with the product rollout, I think earlier when we say it will take a little bit longer than we have expected is mainly because we don’t – we didn’t feel urgency, I think that’s part of our -- we were too complacent, when our revenue was growing really fast, we thought we had more time to make this transition into the content product. But obviously now the entire company have the sense of urgency, and fair focus on the effort. So we do expect to roll out a number of products this year. We rolled out quite a few but I think there’s couple ones that will be our main products in the content product side. We would love to share more with you but given the competitive landscape, we’d rather discuss this after we lunch this product. So that’s our view on the content product side.

The next question comes from Thomas Chong of Citigroup.

[Foreign Language] My question is about the use of cash and M&A strategies. Will management consider to issue new shares or use the existing cash for the funding of upcoming M&A, if there is any? Thanks.

[Foreign Language]

So Thomas thanks, I think Fu Sheng mentioned a couple things. Basically if you look at our – historically we have been free cash flow positive over the past two years. There is no change in our view on that. This year we would likely to see a positive free cash flow. And also, as we mentioned in our earnings call earlier, we have a share buyback program that the board has authorized in the last or the previous board meeting. And we have put that plan into place. So while – although we have not repurchased share up until May 18, the plan is in place. So again, if you look at our investments and operational cash flow requirements -- I think from operational capital requirements, as we mentioned before, we continue to be free cash flow positive and we also have a pretty strong balance sheet right now. So if you look at our cash balance right now, including short term investments, which is mainly CB or fixed short term deposits, we have almost RMB1.8 billion in cash. So I think we have ample of liquidity to support our investment as well as our operations. Now obviously, investment itself, unless we have a very large acquisition, I think we have more than sufficient cash to handle that, but at this point I don’t think we have any plan. And if we do have any plan, we will make the announcement to the public in terms of fund raising of large investment. But as we mentioned, we have not made such announcement. End of Q&A

This concludes our question and answer session. I would like to turn the conference back over to Helen Jing Zhu, IR Director for any closing remarks.

Thank you all for joining our conference call today. If you have further questions, please do not hesitate to contact us. Thank you. Bye.

Thank you.

Thanks.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.