Cheetah Mobile Inc. (CMCM) Q2 2018 Earnings Report, Transcript and Summary

Hello, and welcome to the Cheetah Mobile Second Quarter 2018 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. Please note this event is being recorded. Now, I would like to turn the call over to Helen Zhu, IR Director. Please go ahead, ma'am.

Thank you, operator. Welcome to Cheetah Mobile's second quarter 2018 earnings conference call. With us today are Mr. Fu Sheng, Chairman and CEO; and Mr. Vincent Jiang, CFO. Following management's prepared remarks, we will conduct a Q&A session. A presentation for the company's earnings call is also available at the company's IR website. Before we begin, I refer you to the safe harbor statement 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.

Thanks, Helen. Hello, everyone. Thank you for joining us today. As we said on our Q1 earnings call, we had implemented some initiatives regarding our exciting business, including mobile utility products and the mobile game business. I'm delighted, that the efforts are starting to bear fruit. In Q2, total revenues were nearly RMB1.1 billion beating our high-end revenue guidance by 2%. Non-GAAP operating profits gross by 58 year-over-year to RMB143 million. We now expect our total revenues in Q3 to be in the range of RMB1.29 billion to RMB1.35 billion, representing our 10% to 50% year-over-year growth. This growth will be driving by our utility products and related service business and our mobile games operations. Now I will highlight some of our initiatives around our utility products business and our mobile games operation. First we have been paying more attention to our domestic market. Our mobile utility products in China and overseas market used to be operated by separate teams. We have now combined the teams and appraise many approaches that have been growing affecting in the overseas market to our home market. As a result the DAU of Clean Master exceeded the RMB30 million mark in June in our domestic market. Revenues from mobile utility products in the domestic market grew substantially in the quarter. This growth was achieved even in an unfavorable market environment. We have some Chinese advisors in the news, live streaming and the short video factors scaled back their online promotional activities due to heightened regulation regarding online content. In the overseas market, we have tried our several initiatives to monetize Cheetah Keyboard and have some encouraging initial results. Cheetah Keyboard has accumulated more than 10 million DAU, mainly through organic growth. In Q2, utility products and related services business generated RMB756 million in revenue and RMB282 million in non-GAAP operating profits. It remains as the most important source of cash for us. Second, our portfolio of major games has continued to achieve strong performance. We have introduced popular third-party content into our games to encouraging game purchase. For example, in the quarter we added a new level 2018 Piano Tiles 2 and Rolling Sky, which some popular result, which attracted a loss of active players and allowed us to convert many of them into paying users. Furthermore, the profitability of our major gains continues to increase. Thanks to our operating leverage. We had a temporary delay in launching some new mobile games in Q2, which resulting a decline in revenue in Q2, but we have seen some of our new game Tiles started to run up quickly in early July. Going forward, we expect to continue to launch new games in accelerating pace. Next, I would like to talk about our progress in our AI-powered hardware business. As started in past, our AI-powered smart device business had been jointly developing by Beijing OrionStar. Cheetah Mobile has about 34% equity interest in Beijing OrionStar, and has a two-year balance to gain more equity interests to achieve a concluding position. We hope to leverage Cheetah Mobile's expertise in customer driving products, and AI capabilities of Beijing OrionStar to create more and more smart devices. For example, we have released a voice interactive AI-speaker called Cheetah Voice Pod in March. In July, we released AI interpretation device called Cheetah Translator at an affordable price of about US$40 assisting our users to communicate with the foreign language speakers. The Cheetah Translator has a super user-friendly one patent design selecting automatically identify language being spoken and translated into talking language. Currently the Cheetah Translator supports four languages, English, Chinese, Japanese and Korean. Customers can buy Cheetah Translators on much high e-commerce platforms such as JD.com and Tmall.com. Cheetah Translator has been very well received by the market making the best seller among its peer products. Although the sales from Cheetah Voice Pod and the Cheetah Translator are still insignificant competitors to our overall revenue of Cheetah Mobile, we believe these are important steps for us to develop and enhance our AI-powered smart device business. With that, I will now turn the call to our CFO, Vincent Jiang for Q2 business and the financial updates.

Thank you, Sheng, and hello, everyone. Now let me walk you through the details of our second quarter performance. All financial numbers are in RMB unless otherwise noted. We achieved better than expected financial performances during the second quarter as we are executing our strategy of rejuvenating our revenue growth and expanding our profitability for the remainder of 2018. Total revenues for the second quarter of 2018 were RMB1.10 billion, exceeding our previous guidance range of RMB1.02 billion to RMB1.08 billion. Gross profit increased by 2% to RMB752 million in the second quarter of 2018. Gross margin expanded to 68% from 63% in the same period last year. Operating profits increased to RMB128 million from RMB66 million in the same period last year. Operating margin expanded to 12% from 6% in the same period last year. In Q2, we report is a diluted income per ADS of $1.29, up from $0.47 in the same period last year. Net income attributable to Cheetah Mobile's shareholders for the second quarter of 2018 increased by 180% year-over-year and 181% quarter-over-quarter to RMB197 million. The increase in our profit were mostly due to three factors: first, the disposal of the loss making business News Republic in 2017; second, our efforts in optimizing the cost structure of our utility products and related services business; and last, increases in fair value of certain our long-term investments. One such investment is coding [indiscernible] in Chinese, which is a Chinese online education platform that teaches students how to code and do programs. As of Jun 30, 2018, our cash, cash equivalents and restricted cash and short-term investments were RMB3.52 billion. Our strong cash position has allowed us to continue our investments in AI-powered business, which is an integral component of our long-term growth strategy. Moving on to the details in each of our reporting segments know that starting on January 1, 2018, Cheetah Mobile adopted ASC 606, the new accounting standard for net value added tax out of line items of revenues and cost of revenues. To increase compatibility with the second quarter of 2018 numbers, we have adjusted our 2017 revenue number, net of VAT. For our utility products and related services business, revenues decreased by 5% year-over-year to RMB756 million in Q2 of 2018. The year-over-year decrease was due to, first, decline in PC revenues as a result of the continuous migration of the internet traffic from PC to mobile; second, the decline in revenues from mobile utility products in overseas markets. As we stated in the past, Facebook and Google discontinued the placements of ads on mobile phones lock screens since May 2017 and January 2018, respectively, which in turn reduced our ad inventory. We have made up some of the large revenues by creating new and innovative monetization approaches within our apps. More importantly, the strong performance of our mobile utility products in China has largely offset the weakness in overseas markets. The strength in the domestic market was mainly due to a year-over-year increase in our adding impressions joined by the expansion of our user base in China, as well as the elevation of our user engagement levels. In June, the DAU of Clean Master in China exceeded the 30 million mark for the first time ever. Clean Master remains as a top cleaning app in China according to iResearch. During the second quarter, we also expanded our advertisement base, primarily by working with more mobile advertising platforms such as Xiaomi and Toutiao. This initiative allowed us to increase our EPTM on a year over year basis. Despite a year-over-year revenue decrease in our utility products and related services business, we continue to grow our profits and expand our margins. Our ongoing efforts in optimizing our cost structures combined with a revenue increase from our utility products in China through our profit margin expansion. In the second quarter of 2018, non-GAAP operating profits for our utility products and related services increased by 33% year-over-year to RMB282 million. In non-GAAP operating margins for our utility products and related services expanded to 37%, up from 27% in same period last year. For our mobile entertainment business, revenues decreased by 10% year-over-year to RMB333 million in the second quarter of 2018, mainly as a result of a 9% reduction in revenues from our mobile games business. The revenue decline in mobile games was mostly due to a temporary void in the new titles. However, our existing game portfolio has continued to achieve solid performance, and we expect our mobile game business in the third quarter will resume sequential growth. Summer time is always a high season for our mobile game business and we have seen a few of our new games are gaining momentum in the third quarter. Revenues from our content-driven products decreased by 11% year-over-year to RMB194 million in the second quarter of 2018. The decrease was largely due to the disposal of the News Republic application in the first quarter of 2017 as well as a slight decline in revenues from Live.me, which is a result of continued deprecation of the U.S. dollar against RMB in the second quarter of 2018. Our non-GAAP operating losses for the mobile entertainment business narrowed to RMB99 million in the quarter from RMB122 million in the same period last year. Reduce of losses were primarily attributable to the reduced cost and expenses from News Republic business as we disposed News Republic in Q4 2017. Looking ahead into the third quarter, we currently estimate total revenues for the third quarter to be between RMB1.29 billion to RMB1.35 billion, representing a year-over-year increase of 10% to 15%. We expect our mobile games business and our mobile utility products and related services business in the domestic market to be the main growth drivers. We know that this forecast reflects the company’s current and preliminary view and is subject to change. This concludes our prepared remarks. Operator, we are now ready to take questions. Thank you.

Yes. We will now begin the question-and-answer session. [Operator Instructions] And the first question comes from Wendy Huang with Macquarie.

First, can you give some color about your Q2 guidance? It suggested very strong assumption of growth and what's the driver behind it? And also, secondly, you mentioned about your collaboration with Xiaomi and Toutiao that started in June quarter. Can you give more color about the revenue contribution from this new collaboration? And also how do you expect to be turned out in the second half? Lastly on the margin trend. So this quarter the gross margin can much rather than expected. What's the reason behind that and how should we expect the margin for the second half as well? Thank you.

Okay. Wendy, just hold on a second.

Sure.

Hey Wendy, Let me take the first question about the assumption behind the growth drivers. Actually there are two -- there were the two main growth drivers for the company in the second half. First one is the mobile experience -- is the mobile utility products within domestic market. Since starting Q3, last year, we have seen significant growth in the domestic markets for the utility products because of two reasons. First reason is that the user engage level has been increasing because we have made quite a significant improvement in the products results. And we also see our users agreeing because of that effect also because of we are doing more marketing within China because we are paying more attention to the domestic market now. And also the reason for the growth in the domestic market is we are adding new advertisers basically well diversified our adviser base including the relatively new companies such as internet companies like the short video producers, the news portals, for example. And so that is first driver. And the second driver is the mobile game business. Although we had declining revenues from our mobile games in the second quarter, we are making significant increase in terms of the number of games we are able to launch in the third quarter. We actually, initially we expected that we will have more games in the second quarter to be launched, but because of some delays we were not able to do that in second quarter. But those games had been launched in Q2, the end of the Q2. So right now it's third quarter now. We have seen some encouraging news in the third quarter, especially in September. It's in July and August because the summertime is a high season for us for games. I hope, that answers the first part. [Foreign Language] Okay. The second part [Foreign Language] The cooperation with Xiaomi and Toutiao, I think, there are two parts. First of all, we are expanding our good acquisition channels and Toutiao and Xiaomi are two very effective channels for us to find new users. And secondly, we are adding SDKs and receiving advertise placements from these two platforms, which in a way that increased our ad supplies.

And can you give some color regarding the Xiaomi related to Xiaomi and Toutiao?

Well, in terms of the revenue contribution from Xiaomi and Toutiao is relatively small actually. So the contribution -- there are two ways, first of all, we will able to walk with them to acquire more users, actually this is a most significant part in terms of revenue contribution.

Sure. So how about the margin trend?

We expect our margin actually will continue to improve. There are couple reasons. First, go ahead please. Okay. I'll continue.

Yes, sure. Can you give some…

I'm sorry. Go ahead continue.

Yes, sure. Can you give some color on your better than expected margin in June quarter and also the reason behind further margin improvement in the second half contribution? Thank you.

Well, in terms of the margin expansion, first of all we have the -- when you look at the cost of the revenues, we have -- okay, for the cost of revenues, we have discontinued certain our products, for example, one of which online call, but this is some product which doesn't have good margins we discontinued this product. And also for the IDC and CDM products because of the decrease in terms of the inventory -- ad inventory, so that one comes naturally for the reduction of costs associated with the decrease in the ad inventory. And also for the sales and marketing we are adjusting our sales and marketing expenses. For example, we are decreasing the sales and marketing expenses in developing countries, which helps reduce the -- because of the revenue contribution from those markets are relatively less -- relatively small, so reduction in those markets actually helps to contribute to our margin improvement. Also another reason is actually because of the R&D expenses, which is much smaller than previous years. One reason for the reduced R&D expenses was that first of all we granted more options in equity awards in early years than in 2018. And secondly, because of we using accelerated method to account the expenses, share-based compensation expenses for that -- for those awards, and naturally there has been more share-based compensation expenses in early years than the ones we incurred this year. These are the main reasons.

Thank you.

[Operator Instructions] And the next question comes from Thomas Chong with Credit Suisse.

Thanks management for taking my questions. I have two questions. The first question is about the mobile game market outlook in China given there are different regulatory concerns, and how we ensure our mobile games can have strong growth in the second half? And my second question is about the competition of Clean Master in China? Who are our competitors on utility products? [Foreign Language]

So the casual games business for us in China actually is going pretty good. For example, Piano Tiles 2 and Dancing Line, which are our -- two of our mature casual games, which were in the overseas market, but now they are developing in China in a pretty good way, actually a lot of users are using it. But, of course, because of the recent regulations because new games cannot get a copyright and they cannot be officially released, which will impact the launch of new games in China. [Foreign language]

Okay. For a more complex game, the competition landscape -- the competition is extremely competitive right now in China. But for Cheetah Mobile, we are using casual games, we have casual games and which actually give us a lot of advantages because for many overseas well-known brands or well-known games, and also from other more globalized IP content, Cheetah Mobile does have its own advantages in China. [Foreign language]

Okay. In the past, we had some difficulties to develop in-game features for us. And but fortunately, we have made some breakthroughs in the in-game purchase features. So we think that we do have a lot of opportunities in the future. [Foreign language]

Okay. In China, many cellphone makers do have their phone management tools. For example, Tencent. Tencent has their own management tools. And those are all Cheetah Mobile's Clean Master's competitor. [Foreign language]

Okay. That answers your question.

Thank you.

Thank you.

Thank you. And the next question comes from Robert Cowell with 86Research.

Hi, management, thanks for taking my questions. I actually have two. The first one is about your cash balance. I know that you have quite a bit of cash on the balance sheet. So I'm interested if you have -- strategically, how do you all think about that cash and what do you going to do with it? And then, my second question is about your AI initiatives, and maybe two aspects. One is on the AI voice operating system. I noticed you have quite a high market share in the Chinese market. I'm wondering if there is any plan or avenue to monetize that market share. And then second is on the warrant, how do you all think about converting those warrants and when can we expect that business to start hitting the P&L. I'll try and translate into Chinese. [Foreign language]

Hey Robert, let me take the first question. For the cash on our balance sheet, we are continuing to look for strategic opportunities. We haven't done a few acquisitions in the past and we will continue to do so. We expect to continue to do so in the future, but we will be very careful, very prudent. We have to make sure that opportunity is there before we make any bigger decisions. And the secondly, we are making some smaller long-term investments from time-to-time. As you can see, we have more than RMB1 billion worth of long-term investment on our balance sheet. And we are continued to making smaller investments and for -- especially in these areas that do have potential synergies with Cheetah Mobiles core business, including the online advertising or AI-related products and services. [Foreign Language]

Okay. Yes, indeed the voice interactive operating system developed by OrionStar has a quite significant market shares. For example, Cheetah Mobile's smart speaker also other manufacturers of smart speakers such as Midi, Himalaya and Xiaomi all use, actually all use OrionStar's voice interactive system. Actually for the Xiaomi, part of those, part of their products used OrionStar's voice interactive operating system. For Xiaoya, which is also their smart speaker developed by Xiaomi, the text to speech module is developed by OrionStar. But in terms of the monetization, we think it's still in relatively early stage for the entire industry to monetize. We are still finding a way to effectively, to generate revenue from the operating systems. We think that voice interactive system or smart speakers, it's a new category actually. And it can be the entry point for people to access internet. And depending on the time spent with the AI-speaker and the number of users for AI-speaker, we think there is opportunity. In terms of now, we -- actually, we don't have a huge amount of monetization have been achieved by anyone in this industry. [Foreign Language]

Okay. The second possibility is all included Xiaomi which is GreetBot. It's kind of a receptionist function as a receptionist for business and some commercial settings. We think they are the good opportunities to monetize because we do have won some awards recently for the GreetBot. [Foreign Language]

For the warrants, to purchase additional equity stake in OrionSta, which is a decision to be made by the Board of Cheetah Mobile, so that cannot be answered on this call. Thank you.

Could you remind us when is the deadline for exercise of the warrants?

I think we still have a little more than one year.

Okay, a little over a year. Thank you.

Thank you.

Thank you. And as there are no more questions at the present time, I would like to return the call to management for any closing comments.

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