Cheetah Mobile Inc. (CMCM) Q2 2019 Earnings Report, Transcript and Summary

Good day and welcome to the Cheetah Mobile Second Quarter 2019 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded. I'd now like to turn the conference over to Helen Zhu, Investors Relations Director of Cheetah Mobile. Please go ahead, Ma'am.

Thank you, operator. Welcome to Cheetah Mobile’s second quarter 2019 earnings conference call. With us today are our company's Chairman and CEO, Mr. Fu Sheng; and the company's CFO, Mr. Vincent Jiang. 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 will also apply to our conference call today, as we will make forward-looking statements. At this time, I'd now like to turn the conference call over to our Chairman and CEO, Mr. Fu Sheng. Please go ahead, Fu Sheng.

Thank you, Helen. Hello, everyone. In the second quarter of 2019 total revenues exceeded the high-end of our guidance driven by our robust growth of our mobile games and AI-related business. However, we must admit that our utility product business is still facing some challenges due to the misleading statements made by our third-party in later November 2018 which led to pause in some of our collaborations with business partners in overseas markets. While we have continued to talk with them to clear up this confusion, we have not yet being able to resume business -- business relations with some including Facebook. In the first half of 2019, revenues from utility products and related services decreased by 39% to RMB921 million. In the second half of 2019, we will continue to face the challenge of growing and suspending our utility product business revenues. On a year-over-year basis, the slowdown of our utility products and related services could decrease in our total revenues for the full-year of 2019. We will also continue investing in AI as our AI business still in its early stage of development. As a result, we could report operating loss for the full-year of 2019. Even though we’ve taken several steps to restart the growth of our business, some of the steps have already shown early upbeat results. First, our utility product and related service business continues to make healthy profit and cash flow in the first half of 2019. This business segment earned RMB244 million in operating profit. About RMB400 million MAU continue to be still be a strong source of revenues and a rich foundation for developing new products and service. Second, our mobile games. Mobile games business has continued to grow strongly and had become our growth engine for the company. In the first half of 2019, revenues from our mobile games business grew by 88% year-over-year to RMB591 million. We continue to see the growing user adoption of our mobile casual games in overseas market. According to third-party data, the overall mobile casual game market increased by 100% year-over-year in June 2019, driven by user growth in both developed countries and emerging market, such as India, Russia and Brazil. This rapid progress was also driven by gamers who had never played mobile games before joining our platform. The growing mobile casual game market had continued to put growth in our mobile game business. Cheetah Mobile continues to create hit games. Our games have been downloaded more than 2 million times in the past -- 2 billion times, sorry -- 2 billion times in the past years. Since 2019 we have launched seven games. Some of this games remains top casual games in overseas market and have been featured by either Google or App Store. For example, in late July we launched Beach Clean. Beach Clean is a light casual game that quickly became a top three app and a game on Google play in United states and a number of other developed country. We also continue to explore additional monetization opportunities through our current title by launching in game purchase items and in game rewards. These have helped us to continue growing app -- growing our app. Importantly, our flagship games, including Piano Tiles 2, Rolling Sky, Dancing Line, and Bricks n Balls continue to do quite well and have begun to form a portfolio of well known mobile game IP. In the second quarter of 2019, our flagship game operating margin expanded to 28% from 23% in the same period last year due to better operating leverage. Third, despite the early stage of development, we’ve already launched several popular AI-based products together with Beijing OrionStar. We are also a single largest shareholder of Beijing OrionStar. We believe that development of 5G technology will create opportunity to grow the number of voice and visual interactive product and solution on to the market quickly. Our voice and visual interactive product offering have been used in many place, such as convenience stores, office buildings, KTVs, shopping malls, hotels, after school classes -- class and more. In the first half of 2019, our AI and other revenue increased to RMB80 million from RMB22 million in the same period last year. In the future we will be able to enhance the monetization strength of our AI-related business as user adoption for our service continues to grow. With this in mind, we will continue to invest in and focus on AI to resume our growth. Lastly, I would like to finish my speech today by announcing our Board -- that our Board has declared a cash dividend in the amount of US$0.5 per ADS which will amount to a total cash payment of about US$72 million. Our special cash dividend payment demonstrate our commitment to delivering shareholder value, which we are facing some difficulty. We are confident in our company's long-term potential. We believe that our legacy mobile internet business which include our utility product business, mobile game business and LiveMe will resume to growth in the long run and will remain profitable. In addition, we are excited about some of the new prospects of building a new growth engine around the AI to enterprise service and we’re confident in our long-term return in the AI investment. Despite that our AI business is still in its early stage of development, we’ve sufficient cash to be able to fund this new business. We have also made some good progress in building sustainable business model for the AI business and we hope to see meaningful return on the investment soon. With that, we will now turn the call to our CFO, Vincent Jiang, to go through the details of our second quarter financial results.

Thanks, Sheng, and hello, everyone. I will walk you through the financial results. All money amount are in RMB, unless stated otherwise. For the second quarter, total revenues were RMB970 million, decreased by 12% year-over-year. Revenues from utility products and related services decreased by 44% year-over-year to RMB424 million in the second quarter of 2019, primarily due to slowdown in our overseas mobile utility business as a result of the negative publicity caused by a news article in 2019 and this year's softness of the domestic advertising industry. Revenues from the mobile entertainment business increased by 50% year-over-year to RMB498 million, driven by a 109% year-over-year growth in the mobile game business and an 8% year-over-year growth in the LiveMe business. The increase in mobile game revenue was mainly driven by the strong performance of Bricks n Balls, which started to ramp up in the middle of July 2018. The increase in revenues were primarily driven by higher average revenue per user as LiveMe introduced several new features in the quarter to enhance user interaction, competition and engagement. Please note that the company will began to deconsolidate LiveMe's revenues starting the fourth quarter of 2019. AI and other revenues grew by 236% year-over-year to RMB49 million, mainly driven by the sales of the AI-based interpretation device, Cheetah Translator. Moving to our cost and expenses. To help facilitate the discussion of the company's operating performance without the effect of noncash share-based compensation expenses, the following discussion will be on a non-GAAP basis which excludes stock-based compensation expenses. For financial information presented in accordance with U.S GAAP, please refer to our press release which is available on the company's website at www.cmcm.com. Cost of revenues in Q2 was RMB327 million, a decrease of 7% year-over-year, mainly due to reduced traffic acquisition costs associated with our third-party advertising platform business, partially offset by increases in content and channel costs related to our mobile game business as well as costs associated with the AI business. Gross profit for the quarter were RMB643 million and the gross margin for the quarter was 66%. R&D expenses in Q2 were RMB211 million, an increase of 36% over the corresponding period in 2018, primarily due to an increase in number of R&D personnel of our mobile games in AI-related businesses. Selling and marketing expenses in Q2 were RMB382 million, an increase of 3% year-over-year mainly due to increased promotional efforts for our new mobile games. G&A expenses increased by 18% year-over-year to RMB180 million in the quarter, primarily due to increased professional service fees. Non-GAAP operating loss were RMB22 million compared to RMB143 million in Q2 last year. Moving to each reporting segments. Operating profits for utility products and related services was RMB121 million in the quarter, decrease from RMB282 million in Q2 last year, mainly due to the revenue decrease. Operating loss for the mobile entertainment business was RMB68 million in the quarter, reduced from an operating loss of RMB99 million in Q2 last year, mainly attributable to the increasing operational leverage and stricter cost and expense management for LiveMe and the improved operating profit of our flagship games, partially offset by initiatives to launch new titles. Please note that the company will begin to deconsolidate LiveMe's financial from September 30, 2019. Operating loss for AI and other business were RMB74 million in the quarter, increased from an operating loss of RMB41 million in Q2 last year, mainly due to our step up investments in AI-related business. Now let me provide you with our third quarter revenue guidance. We currently expect total revenues for the third quarter to be between RMB940 million and RMB980 million. Please note that this forecast reflects the company's current and preliminary review and subject to change. Overall, we’re confident that our business remains healthy and I also wanted to emphasize that the company has a very strong balance sheet. As of the second quarter of 2019, we had US$488 million in cash and cash equivalents, restricted cash and short-term investments. We also have US$287 million in long-term investments, which contain several well-known projects and excludes our all-year round investments. In the second quarter of 2019, the company recognized a gain from equity investments of RMB11 million and other income net of RMB34 million, primarily due to increase in fair value of certain long-term investment in this quarter. For example, our investment in Codemao, a Chinese education platform that teaches programming to children, our investment in SuperAtom, an online finance platform focusing on the southeastern Asia markets. Our gains from long-term investment help the company report a net income of RMB49 million. This concludes our prepared remarks. Operator, we are now ready to take questions. Thank you.

[Operator Instructions] The first question comes from Hillman Chan of Citigroup. Please go ahead.

Hi. Hello. Thank you management for taking my question. So my first question is for the third quarter revenue guidance. Could management share more color for each of the business segment into third quarter, please. And my second question will be on the AI and others. Could management breakdown revenue by Cheetah Translator and other AI products and how we should think about in the coming few quarters the strategy on the product launches as far as the monetization model and more importantly the investment, the loss that we are thinking about AI segment? Thank you very much.

Okay. So in terms of the mobile internet, that’s our legacy business, we still -- although we have some short-term disruption due to what happened last year, but still we are very confident by its long-term prospects. To just give an example, we recently launched a mobile game called Beach Clean, which have been ranked top three globally on both App Stores and Google Play. The way we launched this new game, we are not following our old model. We are actually -- we are trying a new approach and in terms of that, the revenue and profitability are still very good. That’s why we are confident that even though with all those disruptions in the past, we are still confident about our long-term prospect and the same applies to the utility products as well. So in terms of the AI to enterprise service business, we understand that this is different from other type of business. It requires longer term investments and also to build the distribution channels, also it takes time. However, we think that the service robot, for example robot that can deliver goods and we have seen very encouraging result from our clients. They’re very eager to try our new products. And in terms of voice related services or delivery robots, we think they’ve lot of room for growth in the near future. In addition, because of the labor cost in the developed countries and we think that there are still a lot of opportunities for us to expand our robot business to the overseas market, so that it is possible that that can reduce the labor cost for the business. So we think that the AI to be we have lot of opportunities here. Okay. Yes, okay. I will take the first part of the Hillman's questions. In terms of Q3 guidance, the -- we can -- in general, we can say that the revenue from the utility products there will be a slight decrease. But the revenue from the mobile entertainment business we will have growth. And the AI and other business segment will also grow as well. In terms -- normally we don’t provide further details in the forecast. So I think that’s all we can say at this point of time.

[Foreign Language]

Okay. Okay. So because we’re trying new business models for both the utility products and games and also for the AI business. So in terms of the forecast, we are relatively conservative. Okay?

Okay. All right. Thank you.

Thank you. Thanks, Hillman.

The next question comes from Thomas Chong of Jefferies. Please go ahead.

Thanks management for taking my questions. I have two questions. My first question is about our revenue growth over the next few years, how should we think about the contribution from the new initiatives as well as the margin profile? Should we expect the margin profile in the future to be very different from what we see at the moment? And my second question is about M&A. Given the facts that our new initiatives takes time to take off. Should we expect any M&A opportunities that the company will pursue doing the transition process? Thank you.

Okay. Let me try to translate, okay? So in terms of AI to business, we’ve been exploring different models. For example, we have been using a type of traditional distribution channels, and we have third parties helping us to deploy our service robots in situations such as KTVs, hotels, courthouse, and we’ve even made some quite good progress in these areas. And we are also exploring new applications for our robots. For example, we have been deploying our robots in places with larger foot traffic, for example, in shopping malls. And we have deployed hundreds of them in those shopping malls. And the consumers, customers are very eager to go to these robots to ask questions such as the location of certain restaurants and whether there are some discount information for certain shops. So this is a new application similar to moving the offline traffic to online traffic. Actually this is the other side of the mobile application, the so-called O2O, right, online-to-offline applications. And in terms of merger and acquisition activities, Cheetah Mobile has established very stable casual games and utility business, and the company right now have been looking for opportunities to invest in AI related areas. We have minority positions in those companies. And we have some quite successful investments actually recently. And we’ve potential synergies between Cheetah Mobile and those invested companies. In terms of larger merger and acquisition activities, we’re open to opportunities. We are not going to acquire large mature companies because they may not be able -- we might not be able to consolidate and acquire business well. So we are looking for new opportunities. To give you an example, OrionStar, which, right now, Cheetah Mobile is a largest shareholder and a business partner, and Cheetah Mobile has the priority or the preference rights to acquire the controlling position in the company, if at one point the OrionStar is growing relatively well and that fits into the overall strategy of Cheetah Mobile. So that answers the second part, I think the questions, Thomas just asked.

Thank you.

And let me go back to your first part of the questions, in terms of the margins of all those different segments, right. Yes, so the -- in terms of the utility products, we expect overall right now our revenue is lower than previous years and the operating margin will be lower accordingly. But I think in the longer term if we are looking past the current couple of quarters, we hope that the margin will go back to what we had in the previous years. And in terms of smart hardware, right now, it's really hard to say. It depends on the mix of our product. Our AI2C [ph] products currently have relatively lower margin because of the competition. But in terms of the AI2B [ph] business, which we maintain, for example, for the shopping mall applications of our service robots and also the delivery robots we just mentioned earlier, we see good gross margin over there. Okay?

Got it. Thank you.

Thanks, Thomas.

[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks. Please go ahead. Thank you all for joining us today. If you have any further questions, please do not hesitate to contact us. Thank you so much. Bye.

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