Helen Zhu - Director, Investor Relations Sheng Fu - Chief Executive Officer Andy Yeung - Chief Financial Officer Analysts Jiong Shao - Macquarie Philip Wan - Morgan Stanley Ella Ji - Oppenheimer Evan Zhou - Credit Suisse Alex Yao - JPMorgan Henry Guo - JG Capital Jeff Hao - China Merchants Securities Anna Yu - ICBC International.

Good day, everyone, and welcome to Cheetah Mobile's Third Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference call. Please note this is being recorded.

At this point, I would like to turn the call over to Helen Zhu, Cheetah Mobile's Investor Relations Director. Thank you..

Thank you, operator. Welcome to Cheetah Mobile's third quarter 2014 earnings conference call. With us today are Mr. Sheng Fu, CEO; and Mr. Andy Yeung, the CFO. Following management's prepared remarks we will open it up for Q&A section.

Before we begin, I refer you to the Safe Harbor Statements in your earnings release, which also apply to our earnings conference 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. Sheng Fu..

number one, user growth; number two, mobile revenue growth; and the number three, the strategic partnerships. First, our user growth, we added more than 56 million monthly active users in the quarter. Our mobile MAUs reached 340 million, a 184% year-over-year increase.

According to App Annie, Cheetah Mobile was the number three publisher for non-game apps on Google Play by monthly downloads in September. Our flagship app, Clean Master, also remained number one in the tool category on Google Play. More than 16 million users reviewed Clean Master and rated it 4.7 out of 5, the highest rating among the major apps.

Our mobile apps continue to gain popularity and the positive word of mouth around the world, driven mainly by our focus on product innovation and the user experience. In September, Clean Master and CM Security were once again awarded the top spot on AV-Test latest assessment of Android security.

In addition to having better served our global users, we have also set up and expanded our R&D operations in Taiwan. Second, mobile revenue growth, led by a significant ramp-up mobile advertising revenues in the overseas markets, mobile revenues grew 628% year-over-year and 48% quarter-over-quarter to RMB113 million.

Mobile now accounted for 24% of our total revenues. After setting up a business development center in San Francisco, we now have relationships with hundreds of mobile advertisers overseas. In addition, we also started our overseas gaming operation by testing a number of mobile games in different overseas markets.

As a result, our overseas mobile revenues accounted for more than 10% of our total revenues in the quarter and will continue to grow significantly in the future. Those encouraging results again suggests our belief and commitment to investing in mobile and global future for our company. Third, strategic partnerships.

As a company, we firmly believe that partnership is one of the best ways to grow our business. In China, we have expanded our partnership with Baidu, Tencent and Alibaba to the mobile site.

Internationally we continued to strengthen and build new partnerships with the key mobile networks to better enhance our mobile monetization, in addition gaining the popularity and quality of our apps. We are able to attract major phone makers to have to promote our apps.

For example, we have recently formed the partnerships with India-based Karbonn and Lava and Taiwan-based HTC to promote our apps. These partnerships and other upcoming partnerships will continue help expand the reach of our apps. Finally, we are delighted to lead the progress of our mobile business so far.

We are still in the early stage of our mobile and global region. To capitalize on the massive opportunity in mobile, we remain committed to invest in the product innovation and growing our user base and user engagement. And that concludes my part of the presentation. I will now turn the call over to our CFO, Andy Yeung..

Thank you, Sheng Fu. Good evening, everyone. We are delighted to again deliver solid financial results that were above our previous guidance. Total revenue grew 158% year-over-year to a new record high of RMB479 million in the quarter, exceeding the higher end of our guidance by 9%.

We are especially excited to see significant progress in our mobile and global vision in the third quarter. As Sheng mentioned earlier, mobile revenues increased by 628% year-over-year and 48% quarter-over-quarter to RMB113 million or 24% of total revenue. We made significant strides in expanding our mobile advertising business overseas.

Overseas mobile revenues accounted for more than 10% of the total revenue in the quarter. As overseas mobile revenues become a significant part of our revenue composition, we will begin to disclose the revenue breakdown based on international versus domestic revenues in appropriate time sometime next year.

Now I will walk you through the details of our financial performance. All financial numbers are in RMB unless otherwise noted. Revenue from online marketing services for third quarter were approximately RMB361 million, an increase of 143% year-over-year and 27% quarter-over-quarter.

The increase was largely due to growth in marketing revenues from key online marketing customers, driven by significant growth of our user traffic.

While we continue to see robust demand from our top three customers, we saw even stronger demand from other advertising customers, including those in e-commerce, online travel and local services sectors, all of which help us further diversify our revenue base.

Most notably, we continue to experience significant growth in our mobile advertising business and was driven by a significant ramp-up in the overseas market. Revenue from IVAS for the quarter was RMB107 million, up 344% year-over-year and 27% quarter-over-quarter.

The increase was primarily due to a larger number of published games and paying users compared to the same period last year, as well as contribution from the recently established online lottery services. Revenue from internet security services and others were RMB10 million, down 18% year-over-year and 16% quarter-over-quarter.

The decrease was primarily due to the company ceasing to promote subscriptions services in a strategic reorientation which started in 2011. Moving on to our costs and expenses, SBC expenses were RMB57 million in the quarter compared to RMB7.6 million in the same period last year and RMB52 million in the previous quarter.

As we stated in the past, we will incur high SBC expenses this year largely due to shares and options granted to management and employees before the company's IPO in May. To help facilitate the discussion of our 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 also available on our website.

Non-GAAP total revenues in the third quarter were RMB110 million, an increase of 194% year-over-year and 34% quarter-over-quarter, mainly due to higher bandwidth and IDC costs from increased user traffic as well as costs associated with the mobile game business.

Non-GAAP gross profit for the quarter was RMB369 million, an increase of 149% year-over-year and 24% quarter-over-quarter. Non-GAAP gross margin for the quarter was 77% compared to 80% in the same period last year and 78% in the previous quarter.

As previously stated, we expect gross margin to continue trending down gradually by 1% to 2% each quarter, given our revenue mix shift. Non-GAAP R&D expenses in the third quarter were RMB120 million, an increase of 90% year-over-year and 36% quarter-over-quarter.

This increase was primarily due to increased headcount associated with the expansion of our mobile business. We added roughly 200 R&D staff in the third quarter and more than 500 in total over the past year. At the end of the third quarter, we have more than 1,200 R&D staff.

Non-GAAP selling and marketing expenses in the third quarter were RMB165 million, an increase of 251% year-over-year and 42% quarter-over-quarter, mainly due to promotional expenses related to expansion of our mobile business and deepening of our global penetration.

Non-GAAP G&A expenses increased by 48% year-over-year and 12% quarter-over-quarter to RMB32 million due to increased headcount and professional fees associated with being a publicly-listed company. Non-GAAP operating profit was RMB52 million, an increase of 224% year-over-year and a decrease of 21% quarter-over-quarter.

Non-GAAP operating margin was 11% compared to 9% in the same period last year and 17% in the previous quarter. Non-GAAP net income was RMB60 million in the quarter compared to RMB30 million in the same period last year and RMB65 million in the previous quarter.

Non-GAAP diluted earnings per ADS was RMB0.43 in the third quarter 2014 or $0.07 per ADS compared to $RMB0.11 in the same period last year and RMB0.49 in the previous quarter. Now let me provide you with our fourth quarter revenue guidance.

We currently expect total revenues for the fourth quarter to be between RMB560 million to RMB570 million, representing a 108% to 112% year-over-year increase. Please note that this forecast reflect the company's current and preliminary view of the market and is subject to change.

Now finally as we mentioned previously, while we continue to experience year-over-year improvement in operating margins in recent quarters, mobile internet is still in its early stages of development. We remain committed to invest in our mobile and global future.

Production innovation, user growth and mobile monetization remain our top three priorities at this point. And with that, we conclude our prepared remarks for today. Operator, we are now ready to take questions..

(Operator Instructions) Our first question is from Jiong Shao of Macquarie..

I was asking about the mix between mobile games and advertising for the mobile revenue and the number of mobile games in China and also the topline for the mobile game launch for the next six to 12 months..

At this time, we do not provide the breakdown between mobile advertising revenues versus mobile games.

The reason we don't do that as we probably discussed in prior call is that we're still fairly early in our mobile monetization and each quarter we will launch some new initiative and that would shift the mix between mobile advertising revenues versus mobile games.

So as we (inaudible) history, for example, we will begin to do mobile monetization in the second quarter last year at the beginning based on amortizing and in the third quarter and fourth quarter beginning to launch our mobile game business and so as you can tell the mix shift.

And then the first quarter, there was mobile game revenue and then the second quarter, as we have disclosed, we have a strong mobile revenue growth in domestic markets. In the third quarter, we have launched our mobile advertising overseas and we've seen very, very strong ramp-up in overseas markets.

So obviously that's again a big shift back to the advertising business. (technical difficulty).

As you can tell, we are still very early in our overseas mobile game operations. We just launched our mobile game operation overseas recently and we're just testing some games right now. And so we'll see very strong potential for overseas gaming operation. So at this point, we have achieved a breakthrough in the overseas advertising business.

And so obviously in the near term, we will see a very strong growth on our mobile advertising business.

And also if you look at Facebook and other mobile internet companies in the overseas market, they also have experienced very strong growth in mobile advertising business and that also strengthens our belief and commitment to mobile advertising business overseas.

So obviously if you look at the Chinese mobile gaming market right now, it's very active, and we're quite successful compared to global peers. Also we have some games that we have lined up to launch in the near future. But before we launch, we don't want to disclose the titles yet.

So one of the things I would like to disclose here is a game called (inaudible). It's a game targeting female audience that has achieved very strong results in the Chinese market. We also get global licensing from the developers and we believe that there's a very strong potential for this game in the overseas market, especially in Japan..

So my second question is about where the company was seeing the biggest momentum among the three top apps the company has, which is Clean Master, Battery Doctor and CM Security.

And I was also asking about any change in competitive landscape since competitors, basically Qihoo launched somewhat similar apps also out of China?.

As we can tell from the data that we have disclosed, the reception and demand for mobile utility application was very strong and perhaps stronger than most people have originally expected. Especially if you look at monetization, I think there was some skepticism about our ability to do monetization for mobile apps.

And as you can tell from this quarter, we have seen very strong results. But right now, we don't want to disclose which app is generating more revenue versus the other.

If you look at the recent market entrants by our competitor, which is not new, actually has entered the market for a while now, maybe with some renewed effort recently, but also see other players that are trying to get into the utility application space.

That basically validates our initial thought that the utility applications are very valuable applications. Now people have probably realized that low-hanging fruit that we have accomplished in the first place.

So if you look at competitive landscape for utility applications, at the beginning it was a single app, but I think we're already seeing a transition from a single app to like a product matrix like what we have done. And with that, we have established a very high barrier or competitive edge over our competitors.

You may occasionally see our competitors make some efforts or spend some money that creates some stop-go in the markets, but if you look at it, none of them are as committed as we are. Our company's 2,000 employees are totally committed our mobile and global future.

And if you look at our ability to cost our product and in terms of our user engagement and also our monetization ability at this time, I think we are way ahead of our competitors.

I think if you look at the market today, as long as we are focusing on our product, user experience, and it would be very difficult for our competitors to actually overcome our competitive edge..

The next question is from Philip Wan of Morgan Stanley..

You mentioned that native advertising was one of the key growth drivers for your advertising revenue this quarter. Just wonder if you could share with us more detail, for example, the percentage or contribution from native advertising, conversion rate of pricing as compared to other non-native advertising, that would be very helpful..

When we mentioned native app, what we meant is that we will create a contextual base or like certain context to display through the advertising. And we are able to try to match that and customize that with our user profiles. And I think with that, we find that we are able to achieve pretty good reception through those advertising.

I think if you look at the ad format or the context, maybe importance, but I think more importantly our ability to actually utilize the data we have and do perform a big analysis on our user base and able to profile our user and match that to our demand for our advertisers, I think that is actually very valuable.

And also our ability to sell advertising to advertisers also help us to boost our mobile monetization in the quarter. In term of different ad formats and the revenues from those different formats, I think at this time we will not disclose it for competitive reasons..

Our next question is from Ella Ji of Oppenheimer..

I have two questions. First, what is the revenue contribution from HongKong Zoom Interactive to your total revenue this quarter? And secondarily, there was a big step-up in both R&D and sales and marketing expenses this quarter.

How should we think about the trend going forward?.

We acquired HongKong Zoom last quarter and integrated into our operations. Before the company was integrated into our operations, it had been doing mobile advertising for four years, but its revenue base was relatively small mainly because due to a early startup, in that sense. But we will continue to increase that operation.

As we mentioned in our press release before, our intention to acquire HongKong Zoom is to acquire the expertise and the team and technology on mobile advertising, and we'll use that as a basis to help us form a base for our mobile advertising technology. And we are pleased with the progress of integration so far.

And again, the revenue contribution is still small, but it is growing pretty rapidly. And the second question regarding R&D spending and sales and marketing, in terms of R&D, we continue to put a high priority on product innovation and product development. So as a result, we will continue to invest in R&D.

In the quarter, the SAP headcount increase was quite significant, about 200 in the quarter. But as you probably know, the third quarter is after summer and generally a season after the graduate land the job. So as a tech company, that's usually a time when we hire more engineers in the third quarter every year.

And then also in sales and marketing, as we also mentioned, we continue to focus on user acquisitions remain one of our focus and we'll continue to invest in that area and also in brand building. But as you can tell, even those are still increasing at a very rapid pace. It has actually moderated from prior quarters.

If you look back in same quarter, for example, I think our sales and marketing expenditure was actually more than 300% year-over-year increase in second quarter. So even though it's still very high, but we're clearly seeing some operating leverage in our model..

If you look at our investment today, you may see it's still a very high level right now. But we're pretty confident that given the pace of our mobile monetization progress, especially in overseas markets, we believe that our investment would yield very positive returns for our investment.

So as you can tell, while we still invested heavily on mobile business, we are definitely spending money carefully to make sure that they're spent effectively to promote our business, our brand and products. And again, we want to emphasize the mobile industry as a whole is still pretty early in its development.

We will continue to invest again in product development, in product innovation, user experience and user base increase..

Our next question is from Evan Zhou of Credit Suisse..

First question is regarding PC Personal Start Page, you saw some minor MAU drop quarter-over-quarter this quarter.

So just wondering if we can have some more color on how do we see the future engagement level and the monetization for this product going forward?.

So if you look at the PC personal directory services, Personal Start Home Page services in terms of user traffic, we have mentioned beginning of the year that we see the overall PC user growth in China was going to be moderating. It's not stagnant.

As we mentioned, IM search data for the user traffic and daily active user and monthly active user numbers. But our tracking data actually indicates that there's not much change in our user traffic. We also want to make sure people pay attention to the fact that the number of 61 million is actually for the month of September.

And if you look at the average of the whole quarter, which is including July and August and September, you'll actually see a mid-teen increase in terms of our monthly active users. The distortion comes in because September is when kids go back to school and what not. At the beginning of the school year, it tends to have an impact on the user traffic.

If you look at PC traffic growth, we're definitely seeing that moderating. But nonetheless, we continue to see opportunities in improving monetization for our PC user traffic, and that coupled with the moderate increase in our user traffic should produce pretty substantial growth in the near term.

As our Chairman, Lei Jun, has said before, there's no sense of fighting a half battle. If you look at the PC industry, PC industry as a whole is definitely going to moderate. And so that's the reason why our company has invested heavily in mobile more than two years ago, and that will continue to be our main focus going forward.

But nonetheless when we look at the PC business, we believe that there is still some growth in the PC business, but people should not have high expectation for accelerating growth in the PC business. That would be unrealistic.

But I think PC growth right now if you look at our growth on PC, it's still very strong, but it will continue to moderate over time, converging into industry average..

Our next question is from Alex Yao of JPMorgan..

As we approach the end of the year, what is the top priority for you guys to achieve for 2015? And how would you allocate the appropriate resource to achieve the target?.

As you can tell, we have been IPO-ed for more than half a year now, and I think everyone can see that we are pretty strong in product development and also in execution. So as we look to 2015, global and user acquisitions remain our key focus.

But as you can tell from the past, we have been very good at executing user acquisitions and our global strategy. So I think that will remain the focus for the next year. Obviously there are some people relatively skeptical about Chinese company's ability to be successful overseas, especially on mobile monetization.

And that has been my personal focus in the third quarter. I spent a lot of time in the US and on the overseas market. And we have seen good progress. After the quarter close in the third quarter, the data in October and early November continue to indicate very strong momentum for our mobile monetization, especially in overseas market.

And as a point of reference for you, recently our mobile overseas advertising business has achieved more than $200,000 per day revenues. So that gives us you some indications on how strong that business is growing right now.

We're pretty confident that in the coming quarter and next year, we'll able to demonstrate our ability to be successful in mobile and global monetization..

Our next question is from Henry Guo of JG Capital..

My question is really about mention that in the prepared remarks that the strategic alliance with the leading Chinese internet companies hired for the topline growth. So I'm wondering whether you can provide more color to help us to understand that.

And also what is the revenue contribution from Baidu, Tencent and Alibaba?.

Our partnership with BAT, the big three customers of ours, continues to expand from our PC platform to the mobile platform. We're not saying that our revenue growth in this quarter is actually driven by those top three customers.

As you noticed in my prepared remarks, we mentioned that obviously the big two customers are part of the growth story for us on the online marketing services. But in fact, we actually see even on the PC side the big three customers were actually doing excellent than our non-big three customers.

If you look at our overall business, obviously we continue to strengthen our relationship with the big three customers, but we will also build new and strengthen our relationship with other customers. In fact if you look at some of other business lines, for example, mobile and gaming operations, we're also growing.

So overall, we think the whole company is running very strong across different business lines.

We don't want to disclose exact number, but if you look at our mobile business, for example, which now accounts for 24% of revenues, and if you look at our mobile revenues, which is 11% of the 24% from overseas, obviously that doesn't rely on the big three customers in China.

And if you look at even in China itself, mobile advertising, for example, we have a lot of advertiser, game developers, app developers, other brand advertisers, so overall if you look at our diversity in our customer base, it continues to expand and increase. So that's something that we're pleased to see..

Our next question is from Jeff Hao of China Merchants Securities..

My question is regarding the MAU contribution between overseas market and domestic market. So the percentage of overseas mobile, you dropped a little bit quarter-on-quarter. So I'm just trying to understand the reason behind that..

One quick clarification. Our goal has also been to try to be a global mobile internet company, not an overseas or international-only mobile internet company. Obviously China is a very important market for us. It's our home market and has always one of the largest user base for us on the mobile side.

So we also have always paid a lot of attention to our Chinese market as well. So if you look at our user base, we have 340 million monthly active users for our mobile business and 65% of that is overseas. That implies that there is more than 100 million monthly active users in China alone.

And when we look going forward, we look at the mobile market in China, US, India. Those will be some of the key markets for us to continue to focus on. If you look at our strong reputation and the quarter-over-quarter, that obviously have a blooming impact on the Chinese market.

The Chinese users and the Chinese players also see the same thing and that should help us form partnerships to help us to promote some of our products in the Chinese domestic market.

As we always have tried to guide investors to look at our overall user growth and set up in any specific country, because there's always some fluctuation perhaps on a quarter-over-quarter or month-to-month basis. If you look at our user base growth in both in China and overseas have grown very strongly on recent months and quarters.

So even if you look at third quarter, for example, we continue to see very strong user growth in overseas market. We will continue to see very strong global user base, overseas base and in China user base.

If you look at our internal structure, for example, the team responsible for the products for the overseas market (technical difficulty) right now, and it's healthy to have some internal competition between those two teams..

Our next question is from Anna Yu of ICBC International..

I have a quick follow-up regarding mobile on we have invested in mobile aggressively for a year.

When do you think is okay for us to start largely monetize the mobile (technical difficulty) from overseas market and we start to see a much stable margin? And also, could you give us breakdown of the internet value-added service business? Which (inaudible) PC game, mobile game and also the revenue contribution from lottery business?.

Regarding the investments in mobile both in terms of R&D and sales and marketing, to be honest with you, when we look at mobile market today, it's still very early stages in its development. So I think in the near future, we will continue to invest in that business. And I think the return for that investment will be very positive over the long term.

Just to give you some point of references, if you look at, for example, Facebook, one of the most successful mobile internet companies today, it has more than 1 billion users and more than 1 billion MAU. So as a company, we set our goal to be a global mobile internet company.

And so we probably won't be happy until we at least see getting close to half of what Facebook was able to achieve in terms of the user base and user engagement. So even if our discussion with leading mobile internet companies like Facebook, they will continue to believe that there is a lot of growth in the mobile user base.

So Facebook, they've got still several billion of consumers yet to be reached by the mobile internet yet. So for them, mobile user accretion remains a top priority. And that's too for us as well.

Of course we understand investors would like to see return for their investment, but we believe that the best way to do it is not by investing in product development or user accretion, but by our ability to increase our ability to generate revenues.

So if you look at our investment, for example, for our mobile product overseas, for a good part of last couple of years, there was no revenue from the overseas market. But we continued to invest in that and grow our user base.

And today if you look at the third quarter, our investment today in the third quarter in overseas mobile market is actually less than what we were able to generate in terms of revenue from those markets. (technical difficulty) transformation. We are moving away from PC.

We are definitely transitioning into an age of mobile era and our investment is in that direction. And you also witnessed our company's increasingly diversifying our revenue base away from China only. You see our mobile revenue overseas are growing very rapidly, for example.

So going forward next year and the year after, we will continue to see that transformation. And even if we use our investment in mobile or global, we will still see our operating leverage returning to our business model gradually. The reason for that is because if you look at our ability to increase our revenue growth, that's fair.

But again, I want to cautious investors for the last couple of years, as we mentioned in the prepared remarks, we have seen a gradual year-over-year operating margin improvement in the last couple of quarters, but profitability is still not our priority. Our priorities remain product development, user acquisitions and monetization.

If you look at our historical financial data, you'll notice that while we continue to invest heavily, we have gradually seen moderations in that investment as a percentage of revenue. I think that trend will continue. At the same time, you'll see our revenues from mobile continue to grow very rapidly. I think we're in that transformation.

Right now, we're still over the past two quarters and today, we're still in investment phase. But gradually, we'll see the operating leverage returning to our mobile operations. We're pretty confident on that..

Our next question is from (inaudible) of Barclays..

My question is on your pre-installation, the cooperation with handset manufacturers.

So do you expect this to become a key contribution channel for Cheetah Mobile going forward? And what's the pre-installation purchase next year and will this have big impact on margins?.

If you look at the mobile market, for example, we still continue to believe that online distribution remains the most important channel. However, pre-installation could act as a supplementary channel. If you look at pre-installations, it's actually heading very good.

So it has become one of the competitive advantage for us compared to our other competitors. Obviously we have (technical difficulty) and we also have other key partnerships that are upcoming. So I think pre-installation could be a very important channel for us our app distribution.

But I think our pre-installations will be different from other players when they do pre-installation partnership. We have deeper integration with OEMs and there is also some exclusivity to our partnership with them. So we think that our partnerships with OEMs are actually a key strength for us as well.

So in terms of budget for installations, nothing that's too much worries for us. We are very careful with spending effectively our dollar. As we look at our mobile monetization, for example, we've seen very strong results. And I think that's more encouraging than the installation cost, for example.

When we look pre-installation, in general we look at a number of key metrics, KPIs to make sure that we spend the money effectively, to make sure that, for example, we generate more revenues and profit from a user than we spend on pre-installation cost. So that's the way how we look at it.

After doing some pre-installations in the recent quarters, we have gained a lot of experience on that and we are pretty confident that we can manage that channel effectively..

This concludes our question-and-answer session. I'd like to turn the conference back over to Helen Zhu for any closing remarks..

Thank you everyone for listening to our call. We look forward to our next conference call with you. And so this concludes our conference call today. Thank you..

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