Cheetah Mobile Inc. (CMCM) Q3 2017 Earnings Report, Transcript and Summary

Good day, and welcome to the Cheetah Mobile Third Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Ms. Helen Zhu, the IR Director of the company. Please go ahead.

Thank you, operator. Welcome to Cheetah Mobile’s third quarter 2017 earnings conference call. With us today are our company’s CEO, Mr. Fu Sheng; and Mr. Vincent Jiang, our company’s CFO. Following management's prepared remarks, we will conduct a Q&A session. Before we begin, I refer you to the Safe Harbor statement in our earnings release, which also applies to our call today as we will make forward-looking statements. At this time, I would now like to turn the conference over to our CEO, Mr. Fu Sheng. Please go ahead, Fu Sheng.

Thanks, Helen, and hi, everyone. Our overall businesses remained healthy in Q3 2017. Our revenue remained stable while our profit and free cash flow continued to improve. Year-to-date, we made RMB3.6 billion in revenue, RMB371 million in non-GAAP net income and RMB336 million in free cash flow. In fact, we had higher non-GAAP net income and free cash flow in the first nine months of 2017 than we did in the full year of 2016. Now, let me give you more details in each of our business lines. Our utility products remain popular among users. Clean Master maintains the highest rating on Google Play. More than 100 million users access the app everyday and more than 30 million users have given it a 5-star rating. CM Launcher remains a personalized app on Google Play in the U.S. and Security Master once again topped the largest test of Android security by AV-TEST. Revenues from our utility products and services remain stable in this quarter, thanks to our large global user base. In the past years, our revenue grew [rapidly] [ph] as smartphones became popular in [developed] [ph] countries. Such growth slowed down as mobile apps market in these countries became mature. We have also built a large user base in emerging markets over the past years. However, the online industry in these markets still lags well behind that of developed countries. We believe that with fast economic growth and the shift from traditional medium to online medium, the time for larger revenue from emerging markets will come. In the domestic markets, our mobile utility products and the services business has been growing. In this quarter, revenue from our domestic utility apps grows by 35% year-over-year and 24% quarter-over-quarter. We believe this growth change will continue in the coming quarters. In addition, we have continued to optimize cost and expense for our utility products and related services. As a result, our non-GAAP operating margin from our utility products and related services expanded to 32% in this quarter, up from 24% in the same period last year and 26% from the previous quarter. Both revenue and profit for our mobile game business continued to grow in the third quarter. We further strengthened our game portfolio to serve nearly 100 million monthly active gamers around the world, which will allow us to further grow our gamer base going forward. We are also encouraged by the fact that our casual games have longer lifecycles than we previously thought. For example, Piano Tiles continued to generate significant revenues with its large user base though it had been in the market for over two years. In addition, we have made progress in turning casual gamers to higher quality users for our mobile casual games. Our Live.me app remains the top grossing social app on Google Play in the U.S. It is also a top app on Apple’s App Store. In addition, Live.me reached $50 million in its round B financing this November. To accelerate our content strategy overseas, we have recently established a strategic alliance with Bytedance or Toutiao, a [wire] [ph] personalized news deliverer has huge market potential. Many Internet giants such as Facebook and Google started to join in overseas. With Toutiao, a leading A.I. powered content platform, we will enhance our first mover advantage overseas and grow our ability to monetize our utility products. Also selling News Republic to Toutiao can help us focus more on our A.I. strategy. Over the past year, we will make large investment in A.I. This helps us better understand and assess our users. In Q3, we solidified our leading A.I. by investing Beijing OrionStar, an A.I. tech company. We believe that a game changer in the industry is to apply A.I. to products and services to meet user needs. As a result, we are using advanced A.I. technology to enhance products and services. I’d like to share some examples with you. First, we use A.I. to strengthen our mobile targeting capability in China. As a result, our eCPMs for result pages grew much in China which in turn helped our mobile ad revenue reach a record high this quarter. In addition, our improved ad tech has attracted more advertisers in key markets such as ecommerce, online services, [auto] [ph] and fintech. Second, we have used facial recognition to better reveal real-time video content from Live.me users. As a result, our workload and the labor costs for Live.me have reduced greatly. Third, we will add A.I. to Cheetah keyboards which can now predict user intent, suggest replies and enable users to type faster on mobile. In the quarter, Cheetah keyboards were featured by Google Play on its global homepage. A.I. has boosted our ability to mind data and then it has processed a large and a mixed amount of language data in real time. As a result, we will be able to deliver more package content to our user and further grow our lead in the global utility space. Our nearly 600 million global Mobile MAUs have laid a solid base for our goals in A.I. In turn, our A.I. tech has led us to better understand our users and create more offering from them such as new mobile casual games, live streaming, short-form video and news. And at that time our ability to deliver A.I. tech packaging content will help us push more relevant content to our users which bring our global distribution power to the next level. Our 30% equity interest in Beijing OrionStar also grows our A.I. ability. It provides us Orion OS, a voice-based operating system that allows a smart device to pickup direct voice commands even in a loud background. Orion OS is best known for its natural and pleasant voice when it talks. It also has many skill sets such as playing music, playing online audio files and giving updates on news and weather. We believe voice-based operating system will become a new gateway for mobile users. It also is an entry point into a major market that is new in China. In China, all OS have several [indiscernible] user base. For example, Beijing OrionStar created the Xiaoya A.I. Speaker with Himalayan, a popular Podcast sharing platform in China. Xiaomi has applied Beijing Orion OS A.I. to Xiaomi’s A.I. speaker and the Xiaomi TV. Also, Beijing OrionStar is working with a number of partners such as Tencent, Xiaomi to create more A.I. driving software and hardware products in the coming quarters. In short, we continued to carry out our strategy of better serving our nearly 600 million Mobile MAUs creating more offerings for them and growing their engagement and time spent on our products. With that, I will now turn the call to our CFO, Vincent Jiang, for Q3 financial update.

Thank you, Mr. Fu Sheng. Hello, everyone. I’m pleased to announce that our overall financial performance was strong in the third quarter of 2017. Our total revenue was robust and our profit and free cash flow continued to improve. Non-GAAP operating profit increased by 303% year-over-year to RMB154 million and non-GAAP net income grew by 123% year-over-year to RMB161 million, hitting a record high. Free cash flow increased to RMB192 million from a negative free cash flow of RMB99 million in the same period last year. The strong performance made a solid foundation for our ambitions in artificial intelligence technologies. Now let me walk you through the details of our financial performance. Please note that all financial numbers are in RMB unless otherwise noted. Our total revenues increased by 6% year-over-year to approximately 1.2 billion in third quarter of 2017. The increase was led by growth in our Live.me and mobile game businesses. Moving to each of our business lines. For our utility products and related services, revenues decreased by 15% year-over-year to 825 million in the third quarter of 2017. The decrease was primarily due to the decline in PC revenues as Internet traffic in China continued to migrate from PC to mobile. In the quarter, PC revenues decreased by 37% year-over-year to 144 million. Revenues from mobile utility products and related services decreased by 7% year-over-year to 688 million due to a decline in impression in the overseas market. As we mentioned in the earnings call for Q2, certain ad formats was discontinued by one of our overseas third-party advertising partners in mid-Q2, and the resulting ad inventory were not fully filled by our other advertising partners. However, mobile revenue contribution from our domestic market hit a record high in Q3. We have leveraged A.I. to strengthen our mobile targeting capability which helped eCPMs improve. Our Mobile MAU also expanded in China which increased by 20% year-over-year to 145 million during the quarter. In addition, we have diversified our source of revenues overseas. Revenues from Facebook decreased to 9% of our total revenues in Q3 2017 from 19% of our total revenues in the same period last year. At the same time, the aggregated revenue contribution from Google, Yahoo!, and Twitter increased to 21% of our total revenue from 15% in the same period last year representing a net increase in revenue of over 87 million. Non-GAAP operating profit for our utility products and related services increased by 14% year-over-year to 260 million in the third quarter of 2017. Non-GAAP operating margin for our utility products and related services increased from 24% in the same period last year to 32% in this quarter. The increase was the result of our strategy to continue to optimize the cost and expense structure of our utility products limited our marketing dollars to our core products in key markets and improved our sales force efficiencies. These efforts coupled with the resilient revenues have allowed our utility products and related services business to improve profitability and generated strong cash flow. For our mobile entertainment business, revenues increased by 124% year-over-year to 362 million in the third quarter of 2017; specifically, revenue from our content driven products increased by 299% year-over-year to 202 million in the third quarter of 2017. Live.me, a popular live video streaming app serving overseas users remained the vast majority contributor of our content revenues. Revenues from our mobile game business increased by 44% year-over-year to 161 million in the third quarter. The growth was mainly due to our efforts to introduce more casual games early this year. At the same time, we have introduced in-game purchase to provide innovative features to our users, thus enhancing users’ game experience. For example, the paying user account on our game, Tap Tap Fish, increased by 150% sequentially in Q3. In addition, some of our mobile games have gained popularity in China. For instance, Rolling Sky has been a top 3 board game in China on Google Play since July 2017. Our non-GAAP operating losses for the mobile entertainment business shrank year-over-year from RMB190 million to RMB105 million. The narrowed loss was primarily driven by year-over-year revenue increase in Live.me and mobile game businesses. In addition, we reduced expenses related to News Republic business. Moving to our balance sheet. We have a very healthy balance sheet. As of September 30, 2017, our cash, cash equivalents, restricted cash and short-term investments were RMB2.4 billion. Our long-term investments were RMB1.1 billion which includes several well known mobile companies that we invested during their early run of fundraising. In third quarter, we gradually disposed of some of our non-core companies which not only strengthened our cash position but also boosted our earnings. A few days ago, we announced the acquisition of Musical.ly by Bytedance or Toutiao. Cheetah Mobile was an early investor of Musical.ly and held approximately 17% of equity interest in the company on a fully diluted and as converted basis as of the end of last year. In addition, we agreed to sell News Republic to Toutiao for $87 million. As a result, we will start to deconsolidate News Republic’s related financials after the closing. We would now like to provide revenue guidance. For the fourth quarter of 2017, we expect total revenues to be between RMB1.25 billion and RMB1.31 billion. Please note that this forecast reflects our current and preliminary views and is subject to change. Overall, our utility products and related services continue to generate strong levels of profit and cash flow which paid off our previous investments and made a solid foundation for our ambitions in A.I. technologies. At the same time, we are optimistic about growing our Live.me and mobile game business in the long term. This concludes our prepared remarks. Operator, we’re now ready to take questions.

We will now begin the question-and-answer session. [Operator Instructions]. The first question comes from Thomas Chong of Credit Suisse. Please go ahead.

[Foreign Language] If I translate my questions in English, first, congratulations on the cooperation with Toutiao. I just want to get a sense about our overseas strategy with Toutiao with regard to content as well as the monetization side? And my second question is about our 2018 revenue and margin outlook, if there’s any? Thank you.

[Foreign Language] . The first point, the strategic alliance with Toutiao greatly strengthens our cash reserve. The second point is that because Toutiao has done many years of personalization content delivery services, so with the strategic alliance and we expect it to combine their content into our tools so that can provide access to hundreds and millions of our users globally. So we expect that will help our revenue growth. And third point is that Live.me has certain rights that if Toutiao wants to have a certain business corporation in overseas market with third-party large streaming business, then Live.me has the priority to provide that kind of service. So we expect that the overall strategic alliance will be a win-win situation for both companies.

Let me take the second question about the overall outlook of the business in 2018. For this part, we expect that the utility products and services will remain stable in 2018 and we expect that it will generate healthy profit and cash flow in 2018 as well. For the mobile entertainment business, we expect that our casual game business and Live.me will continue to have revenue growth in 2018 when you expect that the profitability of the casual games will probably improve because we’re expecting to have more in-game purchase features included in our casual games. And we certainly will expect that the current loss in Live.me will narrow in the near future.

Okay. Thank you.

Thank you.

[Operator Instructions]. The next question comes from Joyce Ju of Citibank. Please go ahead.

[Foreign Language] I will like to translate my own questions. My first question is regarding the mobile games. Given the company has introduced that, they are going to grow their in-game purchase revs, so we would like to get more color in terms of the company’s strategy and potential financial scale on that part of revenue? My second question is related to utility products profitability. We have seen the profitability continue to improve. Wondering if do you helped by more disciplined expenditures in operating expense or it’s coming from like higher gross margin because of the revenue mix change? Thank you very much.

[Foreign Language] So this is a very good question. At this stage we do not disclose a lot about the portion of revenue contribution from the in-game purchase. And [indiscernible] at this stage that this portion is relatively lower. On the other hand, it also means that we have a huge potential for our casual games revenues. As you know that the popular game Honor of Kings has a certain social feature there and you have a very good in-game purchase features that has demonstrated the great potential of games. And so for us we will publish or release a new game with more in-game purchase features. And we expect – we will continue to add more social features to our casual games and add more in-game features so that we hope that we can drive more revenue growth from the casual games.

Okay, now let me take the second question about the profitability of utility products. Well, I think Joyce, you have asked – you’ve made two points that actually answer the question already. First of all, the improving profitability comes from the optimization of our costs and expenses and also we optimize our product structure. Certain not so profitable products we have made some adjustments to that. And the second part is that we do have very good growth for our mobile utility products in the domestic market and that also contributes significantly to the profit growth. Thank you.

Thanks.

Is there a follow-up?

Operator, can we move to the next question please?

Thank you. The next question comes from Wendy Huang of Macquarie. Please go ahead.

[Technical Difficulty]

Excuse me, Wendy. Your voice kind of breaks off.

Sorry.

Your voice kind of breaks off. Can you repeat that question please?

Yes. First, can you give us some color on your partnership with Toutiao? How should we see the impact of this on your 2018 top line?

[Foreign Language] So the purpose of our News Republic business is trying to monetize our user traffic from our utility products and services. By forming the strategic alliance with Toutiao, we can indirectly achieve this purpose because our utility products can still be providing content from Toutiao’s platform and that will help the users of our utility products to increase their engagement and the time spent on our products, which of course will help the monetization of this user traffic. While we do have a revenue sharing program – excuse me, we will have a revenue sharing plan with Toutiao. But by doing this, we will be able to reduce the cost for our R&D expenses and also will reduce some other expenses related to bandwidth and IDC centers and something like that. So overall we expect that our revenue will increase and the profitability will be improved as well.

Thank you. Can we move to the next question please, operator?

The next question comes from Robert Cowell of 86Research. Please go ahead.

Thanks. My question is about the Beijing Orion and specifically the Xiaoya speaker device. So I’m interested in what the market reception has been there? And more generally on Beijing Orion, what is its competitive position or competitive advantage going up against other smart speaker devices or other language-based operating systems? I can try and translate briefly. [Foreign Language]

Okay, Robert, so for the first part of the question about the Xiaoya A.I. speaker, that speaker has been well received by the market and has a very good reputation among its users. And in terms of the time spent per user, unfortunately we cannot comment on that because that product is our business partner’s product. For the second question regarding the competitive advantage of OrionStar, because we think that the A.I. technology has lowered the entry barrier for this kind of applications. And as you know that the Xiaoya speaker and the Orion A.I. technologies do have good reputations. Although the big companies such as Baidu and Alibaba has the potential to have more technology investments. But for us we have a better understanding of the products and of the different usage scenarios because we have been developing products for all these years and we are very experienced in product design and launch by ourselves.

[Foreign Language]

We have very good product managers for all these years.

Thank you. Operator, can we move to the next question please?

This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

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