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Cheetah Mobile Inc. (NYSE:CMCM)

Q2 2018 Earnings Conference Call

Aug. 20, 2018, 8:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

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.

Helen Zhu -- Investor Relations Director

Thank you, operator. Welcome to Cheetah Mobile's Second Quarter 2018 Earnings Conference Call. With us today are our 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.

Fu Sheng -- Chairman & Chief Executive Officer

Thanks, Helen. Hello, everyone. Thank you for joining us today. As we said on our Q1 earning call, we had implemented some initiatives regarding our existing business, including mobile utility products and the mobile game business. I am delighted that the efforts are starting to bear fruit.

In Q2, total revenues were RMB1.1 billion, beating our high-end revenue guidance by 2,000 -- 2%. Non-GAAP operating profit grew by 58% year-over-year to RMB143 million. We now expect our total revenues in Q3 to be in range of RMB1.29 billion to RMB1.35 billion, representing a 10% to 15% year-over-year growth. This growth we'll be driving by our utility products and the related service business and our mobile game operation.

Now, I will highlight some of our initiatives around our utility products business and our mobile game 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 applied many approaches that have been proving effective in the overseas market to our home market. As a result, the DAU of Clean Master exceeded the 30 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 sectors scaled back their online promotional activities, due to tightened 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 product and the related service business generated RMB756 million in revenue and RMB282 million in non-GAAP operating profit. It remains as the most important source of cash for us.

Second, our portfolio of mature games has continued to achieve strong performance. We have introduced popular third-party content into our games to encourage in-game purchase. For example, in the quarter, we added a new level to Dancing Line, Piano Tiles 2 and the Rolling Sky, based on some popular song, which attracted a lot of active players and allowed us to convert many of them into paying users. Furthermore, the profitability of our mature games continues to increase, thanks to our operating leverage. We had a temporary delay in launching some new mobile games in Q2, which resulted in a decline in revenue in Q2, but we have seen some of our new game titles started to run up quickly in early July. Going forward, we expect to continue to launch new games in an accelerated pace.

Next, I would like to talk about our progress in our AI-powered hardware business. As stated in past, our AI-powered smart device business had been jointly developed by Beijing OrionStar. Cheetah Mobile has about 34% equity interest in Beijing OrionStar and has a two-year warrant to gain more equity interest to achieve a controlling position. We hope to leverage Cheetah Mobile's expertise in customer-driving products and the AI capabilities of Beijing OrionStar to create more and more smart devices. For example, we've released a voice interactive AI speaker called Cheetah Voicepod in March.

In July, we released a AI interpretation device called Cheetah Translator at an affordable price of about $40, assisting our user to communicate with foreign language speakers. The Cheetah Translator has a super user-friendly one-button design that can automatically identify language being spoken and translate it into talking [ph] language. Currently, the Cheetah Translator supports four language; English, Chinese, Japanese and Korean. Customers can buy Cheetah Translators on multiple e-commerce platforms, such as JD.com and Tmall.com. Cheetah Translator has been very well received by the market, making it as a best-seller among its peer products. Although the sales from Cheetah Voicepod and Cheetah Translator today are still insignificant compared to the 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.

Vincent Jiang -- Chief Financial Officer

Thank you, Sheng. 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 profit 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 reported a diluted income per ADS of $1.29 (sic) [RMB1.29], up from $0.47 (sic) [RMB0.47] 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 profits 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 of our long-term investments. One such investment is (inaudible) in Chinese, which is a Chinese online education platform that teaches students how to code computer programs.

As of June 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 the 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. You 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 comparability with the second quarter 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, a decline in PC revenues as a result of the continued migration of Internet traffic from PC to mobile. Second, a decline in revenues from mobile utility products in overseas markets. As we stated in the past, Facebook and Google discontinued their placements of ads on mobile phone lock screens since May 2017 and January 2018, respectively, which in turn reduced our ad inventory.

We have made up some of the lost 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 the overseas market. The strength in the domestic market was mainly due to a year-over-year increase in our ad impressions, driven 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 the top cleaning app in China according to iResearch.

During the second quarter, we also expanded our advertiser base, primarily by working with more mobile advertising platforms, such as, Xiaomi and (inaudible). This initiative allowed us to increase our eCPM 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 the revenue increase from our utility products in China drove 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. The non-GAAP operating margin for our utility products and related services expanded to 37%, up from 27% in the 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. Summertime is always the 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 the result of continued depreciation of US 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. The reduced losses were primarily attributable to the reduced cost and expenses from the News Republic business, as we disposed of 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 game business and our mobile utility products and related services business in the domestic market to be the main growth drivers. Please note that this forecast reflects the company's current and preliminary view and is subject to change.

This concludes our prepared remarks. Operator, we're now ready to take questions. Thank you.

Questions and Answers:

Operator

Yes, thank you. We will now begin the question-and-answer session. (Operator Instructions) And the first question comes from Wendy Huang with Macquarie.

Wendy Huang -- Macquarie -- Analyst

Thank you. First, can you give some color about your Q2 guidance? It suggested very strong assumption of the growth and what's the driver behind it? And also, secondly, you mentioned about your collaboration with (inaudible) that started in June quarter. Can you give more color about the revenue contribution from this new collaboration, and also how do you expect it to trend [ph] up in the second half? And lastly, on the margin change, so this quarter the gross margin came much better than expected. What's the reason behind it and how should we expect the margin for the second half as well? Thank you.

Helen Zhu -- Investor Relations Director

Okay. Wendy, just hold on a second.

Wendy Huang -- Macquarie -- Analyst

Sure. (Technical Difficulty)

Fu Sheng -- Chairman & Chief Executive Officer

Hey, Wendy, let me take the first question about the assumption behind the growth drivers. Actually there are two -- there will be two main growth drivers for the company in the second half. First of all, is the mobile utility products within domestic markets. 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 engagement level has been increasing, because we have made quite a significant improvement in the products itself and we also see our users are growing 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 we're diversifying our advertiser base, including the relatively new companies, such as internet company like the short video producers, the -- and news portals, for example. And so, that is the first driver.

And the second driver is the mobile game business. Although we had a decline in revenues from our mobile games in the second quarter, we are making a 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 Q2. So right now it's third quarter now, we have seen some encouraging news in the third quarter, especially in September -- excuse me, in July and August, because the summertime is the high season for us for the games. So that answers the first part.

[Foreign Language] Okay, the second part. [Foreign Language] Well, for the cooperation with Xiaomi and Tujia [ph], I think it is two-part. First of all, we are expanding our user acquisition channels and Tujia [ph] and Xiaomi are two very effective channels for our -- for us to find new users. And secondly, we are adding SDKs and receiving advertised placements from those two platforms, which in a way that increased our ad supplies.

Wendy Huang -- Macquarie -- Analyst

Can you give some color regarding the revenues related to Xiaomi and Tujia [ph]?

Vincent Jiang -- Chief Financial Officer

Well, in terms of the revenue contribution from Xiaomi and Tujia [ph], it's relatively small actually. So the contribution, it's two ways. First of all, we were able to work with them to acquire more users. Actually, this is a more significant part in terms of revenue contribution.

Wendy Huang -- Macquarie -- Analyst

Sure. So how about the margin trend?

Vincent Jiang -- Chief Financial Officer

We expect our margin actually will continue to improve. There are couple of reasons. First -- Go ahead please. Okay, I'll continue. I'm sorry, go ahead, Wendy.

Wendy Huang -- Macquarie -- Analyst

Sure. Can you give some color on your better-than-expected margin in June quarter and also the reason behind the further [ph] margin improvement in the second half in the two divisions [ph]? Thank you.

Vincent Jiang -- Chief Financial Officer

Well, in terms of the margin expansion, first of all, we have the -- you look at the cost of the revenues, we have -- OK, for the cost of revenues, we have discontinued certain old products, for example, one of it is the online call [ph]. This is some product which doesn't have good margins, we discontinued this product. And also for the IDC and CDN 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 decreasing 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 to reduce the -- well, because of the revenue contribution from those markets are relatively less -- relatively small, so the 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. The one reason for the reduced R&D expenses was that, first of all, we granted more options and 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 the -- for those awards. And naturally, there will be more share-based compensation expense in early years than the ones we incur this year. Those are the main reasons.

Wendy Huang -- Macquarie -- Analyst

Thank you.

Vincent Jiang -- Chief Financial Officer

Thank you.

Operator

Thank you. (Operator Instructions) And the next question comes from Thomas Chong with Credit Suisse.

Thomas Chong -- Credit Suisse -- Analyst

Hi. Thanks management for taking my questions. I have two questions. The first question is about the mobile games market outlook in China, given there are different regulatory concerns and how we ensure our mobile games can have a strong second -- 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]

Vincent Jiang -- Chief Financial Officer

[Foreign Language] So the casual games business for us in China, actually they're growing pretty good. For example, the Piano Tiles 2 and Dancing Line, which are the two -- 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 the copyrights 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 is extremely competitive right now within China. But for Cheetah Mobile, we are using casual games. We're having 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] In the past, we had some difficulties to develop in-game features for us. But fortunately, we had 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 own full 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 has the answer to your questions.

Operator

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

Robert Cowell -- 86 Research -- Analyst

Hi management, thanks for taking my questions. I actually have two. The first one is about your cash balance. I notice 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 plan 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 notice you have quite a high market share in the Chinese market. I'm wondering if there's any plan or avenue to monetize that market share. And then second is on the warrants. 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]

Vincent Jiang -- Chief Financial Officer

Robert, let me take the first question. For the cash on our balance sheet, we are continuing to look for strategic opportunities. We have 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 the opportunity is there before we make any bigger decisions. And 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 -- continue to making smaller investments for -- especially in these areas that do have potential synergies with Cheetah Mobile's 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 acquired significant market shares. For example, Cheetah Mobile's smart speaker also -- other manufacturers of smart speakers, such as MIDI [ph], Ximalaya and Xiaomi, all they use -- actually, all use OrionStar's voice interactive system. Actually, for the Xiaomi, part of those -- part of their products use OrionStar's voice interactive operating system. For Xiaoya, which is also the 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 a 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. It can be the entry point for people to access Internet. And depending on the time spent with the AI speaker and the normal 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 (inaudible) which is the GreetBot. It's kind of a receptionist -- function as a receptionist for business and some commercial settings. We think there are good opportunities to monetize, because we do -- have won some awards recently for the GreetBot.

[Foreign Language] Right. For the warrants, to purchase additional equity stake in OrionStar, which is a decision to be made by the board of Cheetah Mobile. So that cannot be answered in this call. Okay. Thank you.

Robert Cowell -- 86 Research -- Analyst

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

Vincent Jiang -- Chief Financial Officer

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

Robert Cowell -- 86 Research -- Analyst

Okay. A little over a year. Alright, thank you.

Operator

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.

Helen Zhu -- Investor Relations Director

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

Operator

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

Duration: 40 minutes

Call participants:

Helen Zhu -- Investor Relations Director

Fu Sheng -- Chairman & Chief Executive Officer

Vincent Jiang -- Chief Financial Officer

Wendy Huang -- Macquarie -- Analyst

Thomas Chong -- Credit Suisse -- Analyst

Robert Cowell -- 86 Research -- Analyst

More CMCM analysis

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Source : https://www.fool.com/earnings/call-transcripts/2018/08/20/cheetah-mobile-inc-cmcm-q2-2018-earnings-conferenc.aspx

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