Welcome to the Cheetah Mobile Second Quarter 2016 Earnings Conference Call. [Operator Instructions] Please note this conference is being recorded. .

I would now like to turn the conference over to Helen Zhu. Please go ahead. .

Thank you, operator. Welcome to Cheetah Mobile Second Quarter Earnings Conference Call. With us today are Mr. Fu Sheng, CEO; and Mr. Andy Yeung, CFO. Following management's prepared remarks, we will conduct a Q&A session..

Before we begin, I refer you to the safe harbor statement in our earnings release, which also applies to our 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. .

Thanks, Helen. Hello, everyone. As we said on our first quarter earnings call, we had challenging beginning in the second quarter and set out to implement a series of initiatives to restart growth and improve our financial performance and establish a sustainable and profitable growth model for the long term.

The centerpiece of our plan is to transform -- is the transformation of our company from a mobile utility app company to a content-driven mobile Internet company, moving speedily in the ways that determine patience and much hard work from our staff. I'm delighted that these efforts are starting to bear fruit. .

Our shorter-term -- short-term initiatives, which includes -- included refreshing our existing app products and ad layouts as well as improvements in our sales programs, particularly for direct sales, have helped us to spoke -- stop mobile revenue declines that look -- took place in the early part of this year.

In fact, we delivered better-than-expected total revenue growth in the second quarter. We now expect revenue to resume quarter-over-quarter growth in the second half this year, driven by steady and sustained revenue growth generated by our existing utility apps and the continuous improvements in our sales programs. .

But more importantly, we also made solid progress on our content strategy. With the recent product rollouts, our content-driven product portfolio now includes news service; short video; live streaming; and of course, casual games.

Most notable -- notably, 2 of our content-driven products, News Republic and Live.me, showed strong performance over the past quarter, particularly in the U.S. market. .

To accelerate our news app launch [indiscernible] worldwide, we recently acquired News Republic for USD 57 million. The France and San Francisco-based News Republic is a global mobile news service operator with thousands of high-profile media partners around the world.

Although News Republic is now a wholly owned subsidiary of Cheetah Mobile, the award-winning News Republic app will continue to operate on a stand-alone basis.

In fact, with continued improvements and the support from Cheetah since the acquisition, News Republic has been moving up on the app charts and was ranked as one of the top 3 news and magazine apps in U.S. on Google Play in July according to App Annie's. .

Live.me, a live streaming app which was developed in-house and recently launched, was ranked as one of the top 3 (sic) [ 5 ] social apps in U.S. on Google Play in July and recently has been ranked as one of the top 3 (sic) [ 10 ] social network apps in U.S. on Apple App Store.

So far this quarter, the successful growth of Live.me has continued as we see user members growing rapidly..

On the light casual games side, Piano Tiles 2 and Rolling Sky continued to perform as well and were both among the top 5 most downloaded mobile games in the U.S. according to App Annie's. Whilst we are encouraged by progress of our content strategy so far, I would stress that, at our core, Cheetah is a technology product company.

We know that our continuing success, be it in the utility app space or the content-driven app space, reflecting our ability to leverage the big data generated by our 600 million fast acting monthly mobile users and our ability to develop the best application with the best experience for our users. .

In the mobile age, content consumption has become more fragmented, and the content is increasingly being pushed to rather than pulled by mobile users. So far, our content strategy is delivering more personalized and relevant content to users when and where they want it. Hence, we continue to invest heavily in our data analytics. .

On the user side, we are deploying big data analytics to help us better understand and profile the wants and the needs of our users. On the content side, we are using AI and machine learning algorithm to better analyze and profile the millions of videos, graphics and effects generated by our users and content partners on a daily basis.

The ongoing success of our news app, Instanews, in India shows that our algorithm work well in delivering more custom and relevant content to our users accurately and efficiently despite only having [indiscernible], culture and the language in-house. .

Finally, while we don't want to downplay the challenge we face in our transformation from a utility app-based mobile company to a content-driven mobile company, our initial success give us the confidence that we are on the right track to improve our growth and profit profile and progress better according to the plan -- according to plans.

Looking ahead, we remain focused on aggressively executing our content strategy to establish a sustainable and profitable growth model for the long term. .

With that, I will hand over the call to our CFO, Andy. .

Thanks, Sheng. Hello, everyone. First of all, I'm pleased that we delivered better-than-expected total revenue growth in second quarter, thanks to our successful strategy to rejuvenate revenue growth in 2016, including refreshing our products and ad layout as well as improving direct sales program.

But given the importance of the transformation that we are undertaking this year, there are a few moving parts in our business model.

So to help you to better understand the performance of our business operations, I will first give you an overview of our financial performance and some additional colors on our existing businesses as well as the level of investment and progress that we are making in our new content-driven products. .

In the second quarter, total revenue grew by 18% year-over-year to RMB 1.05 billion, which exceeded the high end of our revenue guidance by almost 5%. New content products, including the newly acquired News Republic, accounted for roughly 1% of total revenues in the quarter. .

While we incurred a net loss of RMB 150 million on a GAAP basis and a net loss of RMB 62 million on a non-GAAP basis, the decline in net income was largely attributable to a onetime noncash investment impairment of RMB 95 million and step-up investments in new content-driven products, which amounted to roughly RMB 15 million in the quarter. .

In fact, we generated roughly RMB 130 million operating cash flow and almost RMB 90 million in free cash flow in the second quarter. Excluding SBC expenses and the impact of our new content-driven products, our existing products would have generated 17% year-over-year increase in revenues and almost RMB 55 million [ph] in operating profit. .

Looking ahead, for the third quarter, we currently expect and estimate total revenues for third quarter to be between RMB 1.0 billion and RMB 1.15 billion, representing a 7% to 12% year-over-year increase and 5% to 10% growth quarter-over-quarter. Please note this forecast reflects the company's current and preliminary view and is subject to change.

The implied quarter-over-quarter growth was primarily driven by a resumed sequential mobile revenue increases, thanks largely to steady and sustained revenue growth generated by our existing utility apps. .

In the second half of 2016, we will continue to implement strict cost controls. In the future, we will be more focused on optimizing our marketing spending, shifting some of our promotional activities on utility apps on to content-related spending and focusing more on specific developed markets.

Our goal is to sustain revenue growth, albeit more moderate growth, and expand profitability of our existing business while stepping up investments in order to build up on the success and accelerate the growth of our new content-driven products. .

In the third quarter, we expect to invest roughly RMB 115 million in content, R&D and marketing for our new content-driven products on the -- mostly through the profits generated from our existing businesses.

All in all, we expect this initiative to continue to drive our overall financial recovery, starting from the third quarter, and lay a solid foundation for another round of strong monetization, revenue growth and profitability improvements in the coming years. .

one, the decline in mobile MAUs for Piano Tiles 2, which has entered into the mature stage of its product life cycle; two, the company's decision to focus on developed market. The MAUs for the company's core utility application continues -- remained flattish quarter-over-quarter.

The company's mobile MAUs in the developed markets, including North America and Europe, increased modestly quarter-over-quarter. In the second quarter, total revenue grew by 18% year-over-year to RMB 1.05 billion. .

By platform, mobile revenues grew by 37% year-over-year to RMB 772 million for the second quarter. Mobile revenues accounted for 74% of our total revenues in the quarter, up from 64% in the prior year period. PC revenue declined by 15% [ph] year-over-year in the second quarter.

The decreases in PC revenues were mainly due to the migration of Internet traffic from PC to mobile in China. .

By region, overseas revenue were RMB 561 million for the quarter, up 25% year-over-year. Overseas revenues accounted for 54% of total revenue or 33% (sic) [ 72.6% ] of mobile revenues in this quarter. China revenues increased by 11% year-over-year.

The China revenue growth was supported by continued revenue increase from our mobile advertising business in the domestic market. .

By segment, revenues from online marketing services were RMB 939 million for the quarter, up 24% year-over-year. The increases were driven by our mobile user base and increased demand from advertisers as well as monetization of our light casual games through in-game advertising. .

Revenues from IVAS for the second quarter were approximately RMB 80 million, a decrease of 27% year-over-year. The decreases were primarily driven by a decline of our mobile games publishing revenues in China, which offset our growth in overseas markets.

Revenues from Internet security services and others for the quarter were approximately RMB 28 million, an increase of 42% year-over-year. The increase was primarily due to the increases in Internet software licensing revenues contributed by Kingsoft Japan. .

Moving on to our cost and expenses. SBC expenses for the second quarter were approximately RMB 89 million compared to RMB 56 million in the same period last year. To help facilitate the discussions of the 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 U.S. GAAP, please refer to our press release, which is available on our website..

Non-GAAP cost of revenue for the second quarter were RMB 355 million, up 59% year-over-year.

The increases were primarily due to stepped-up investments in content for our content-driven products and an increase in traffic acquisition costs associated with our third-party advertising publishing business on the Cheetah Ad Platform and an increase in bandwidth and Internet data center costs associated with increased user traffic and data analytics.

Non-GAAP gross profit for the second quarter was RMB 692 million, up 4% year-over-year. .

Non-GAAP R&D expenses for the second quarter were 179 million -- sorry, RMB 178 million, up 38% year-over-year. The increases were primarily due to the increased headcount associated with our stepped-up investments in big data analytics and new product developments. At the end of the quarter, we had approximately 1,800 R&D personnel. .

Non-GAAP sales and marketing expenses for the second quarter were RMB 406 million, up 17% year-over-year. The increase was primarily due to the spending on promotional activities for our content-driven products. This increase was also due to an increase in the number of sales and marketing staff. .

Non-GAAP G&A expenses for the second quarter were RMB 123 million, up 43% year-over-year. The increases were mainly due to increased headcount associated with being a public company and higher staff benefits. .

Other operating expenses -- sorry, other operating income was RMB 40 million for the second quarter of 2016. Other operating income primarily consisted of government grants, subsidies and financial incentives. Non-GAAP operating profit for the second quarter was RMB 26 million, a decrease of 71% year-over-year. .

The company recognized impairment losses of long-term investments of RMB 95 million for this quarter, primarily driven by onetime noncash write-downs in certain investment assets. Non-GAAP net loss for the second quarter were RMB 62 million as compared to non-GAAP net profit of RMB 116 million for the second -- for the same period last year.

The losses were partly attributable to stepped-up investments incurred in content-driven product and the RMB 95 million net impairment loss of investments in this quarter. .

Non-GAAP diluted loss per ADS for the second quarter were RMB 0.44 or USD 0.07 as compared to non-GAAP diluted earnings per ADS of RMB 0.81 for the same period last year. Adjusted EBITDA for the second quarter was RMB 68 million, a decrease of 46% year-over-year. .

Lastly, before we start Q&A session, I would like to remind investors and analysts that in March 2016, the Board of Directors authorized a 1-year share repurchase program, allowing the company to buy back up to USD 100 million in aggregate value of its ADS.

As of August 18, 2016, the company has repurchased a total of 2.54 million ADS, representing 25.4 million Class A ordinary shares at an average price of $10.75 per ADS. The share repurchase program reflects our belief that our share is presently undervalued and demonstrates our confidence in the long-term outlook for our business. .

This concludes our prepared remarks for today. Operator, we are now ready to take questions. .

[Operator Instructions] Our first question comes from David Sun of Morgan Stanley. .

[Foreign Language].

So my question is that, can management provide some updates on the overall -- the [indiscernible] advertising revenue, especially the revenue around Facebook? The new guidance, the sequential improvement, does it imply that the revenue from Facebook is recovering? And also, what's the current eCPM trend of the ad from Facebook?.

Okay. .

[Foreign Language].

Okay. Thank you, David, for your questions. So I will translate for Fu Sheng. So in response to your question, I think, in addition to Facebook, I think, overall, we have made particular initiatives, as we mentioned in our prepared remarks, in the quarter to rejuvenate our revenue growth.

Those efforts included our shift in focus from domestic market to -- [indiscernible] into developed markets, where user traffic actually has increased and also monetization actually is also stronger.

In addition to that, we also -- while we don't talk about single customer relationship or specific about a single customer, we will just say that, in general, with our [indiscernible], we also have worked with a number of partners in addition to Facebook.

In addition to that, we also have some initiatives to improve our direct sales force, which has also strengthened the [indiscernible] results right now.

So all in all, this is a combination of many factors in the quarter -- in the second half of the quarter that allowed us to restart the revenue growth in the second half year -- the second half this year. .

Our next question comes from Evan Zhou of Crédit Suisse. .

[Foreign Language].

Briefly translating our -- my question. First question is regarding the content product -- newly launched content product. Revenue contribution, according to the prepared remarks, is probably around 1% [ph]. Just wondering how will that trajectory be in the following quarters.

And specifically on the live broadcasting product, Live.me, I was wondering if I -- maybe Fu Sheng can share with us some insights about the competitive landscape in the U.S. and the developed market and also how does he think about how this product can evolve to contribute more to our company. .

Thank you, Evan, for the questions. So I would take the first question regarding revenue contribution from our new product -- new content products. So our new content products are actually including more than Live.me. Obviously, Live.me is making strong progress in the quarter, but we also have a news service, as we mentioned.

In India, we have Instanews and also, globally, we recently acquired News Republic. So -- and then we also have a couple of other new content applications in the marketplace.

All new products are now contributing about -- roughly 1% of our revenues, and we do not expect content products to really become a significant part of our revenue until 2017 at least. The main reason is because as we roll out new products, while we test monetization, but we generally are not efficient at the beginning.

Our goal right now is, as we have shown in the second quarter, roll out new products and then try to improve those products and then acquire more users. And then, over time, once we have the user traffic, then we are beginning to think about more success rates [ph] on monetization.

So for the third quarter and the fourth quarter, you can expect some more increase in revenue contribution from the new content products, but they are not going to be material at least as far as we can see at this moment. I will let Fu Sheng, actually, answer your second question regarding his view on the live streaming video operations in U.S.

and other countries. .

[Foreign Language].

Right. So live streaming, I think, is not as phenomenal in China, but if you look at probably the future of live streaming, very exciting. If you look at Facebook, I think their founder and CEO there actually mentioned live streaming is one of the most selling products being launched in recent years.

So in terms of our new products, we have launched our products about 2, 3 months ago, and as you can see on app store, both Google Play and on Apple App Store, they have been received very well by users. And we get very high ratings for our products.

So our products are very competitive and have more advantages compared to other products [indiscernible]. As we mentioned in our prepared remarks, you can see that Live.me in the U.S. actually did quite well. It has been ranked as the top 5 social app in -- on Google Play in U.S.

And if you look in August, it was top 10 of social networking apps on Apple App Store [ph] in the U.S. So I think we are confident that our products are very good and competitive in the marketplace. .

[Foreign Language].

The question is regarding the related -- yes?.

Go ahead, sorry. .

Yes. Let me briefly translate. So the question is regarding the cost that's involved in upcoming quarters regarding pushing out new product.

I was wondering what's kind of nature behind the mix of the costs? Is it more related to the app installed base volume that will be acquired for external traffic? Or is it more related to some content spending that's related to acquiring quality content in our new products, such as News Republic and Live.me?.

content, acquire the content, invest in R&D, not only in the product but also in data analytics, machine learning, all the technological stuff that we need to develop in order to have a wonderful user experience for our app user and also for promotion of the applications.

And promotion not necessarily means installations between [indiscernible] in the U.S. So there is no limit to like online marketing, but also including brand, part of promotion activity that we organize to help promote our application and the branding of those applications. So hopefully, that has addressed that question. .

Our next question comes from Andy Wong (sic) [ Wendy Huang ]of Macquarie. .

This is Wendy Huang from Macquarie. .

[Foreign Language].

So I have 3 simple questions. The first is actually about the revenue recognition of the News Republic, Rolling Sky, Piano 2, et cetera, whether you are actually booking it under the online marketing services or the value-added services.

And second is how much of your Q2 revenue guidance actually is coming from the -- those 3 things that I just mentioned? The last thing is about the gross margin trend. It seems like gross margin declined a little bit in the quarter.

What's the reason behind it? And how should we expect the trend going forward?.

Okay. So Wendy, thank you for the questions. So thanks for the questions. In terms of where the revenue is going on the new product -- attributed -- for News Republic as well as Live.me, mainly in the online marketing services.

For Rolling Sky and also for Piano Tiles 2, those are the 2 casual games that we have, also mainly in the online marketing services. Plus we monetize it mainly through advertising, although we do have some revenue contribution from those 2 games in IVAS because there's also some small contribution from users purchasing in-game items.

So the second question regarding our guidance, as we mentioned, for those 3 products -- for our content products, we don't disclose guidance for the games themselves, but if you look at Live.me, News Republic, the news services, as well as a couple of other apps that we have rolled out recently, those products would continue to represent a small portion of our revenues.

We expect some increase but not that big an increase at this point. As we mentioned, right now, our main focus for those new content products is now on refining those products and acquiring more users, not monetization at this point. But we do expect them to continue to grow.

In terms of the valuation for News Republic, we -- look, we -- the total price for acquisition was about USD 57 million.

We did not disclose the valuation matrix that we used, but as we mentioned, the revenue contribution from all 3 -- sorry, our content products that's making up our new product portfolio right now, News Republic is only one of them, and so the revenue contribution is very limited.

Given the scale of the revenues, they have incurred losses rather than -- I'm sorry, they are actually loss-making trends than profit-making. So that will probably be the case for at least a couple more quarters until we begin the monetization for the products.

But again, I mean, our first job here is really to set up [ph] good properties, have a strong brand, [indiscernible] user. Our goal is really to give them support to improve the product and then also, over time, to help them improve the distribution of applications and acquire a large user base there.

And then the last question, I think, is about gross margins. The gross margin declines are mainly attributable to increase in content with -- costs. [indiscernible] as those products grow in terms of user and revenues, we will see improvement on the gross profit margin.

But at this time, there's scale in competitive revenues, so we do incur a higher content cost as a percentage of revenues right now. .

So how should we expect the gross margin trend going -- so should we expect the content costs to trend -- continue to trend higher in the future quarter as well?.

It should not be that much higher. Obviously with, first of all [ph], a lot of product, a lot of costs that we didn't incur before show up. But the incremental increase should not be that large. And I think the products -- you can look at the low 60% margin -- gross margin. That's a fairly reasonable way to look at it.

But I think, at the same time, we probably have a couple more months [ph] to go just because some of these products are still ramping up in content. But I think 60% is probably a reasonable way to look at it. And then as those products ramp up in revenues, we should begin to see gross margin being able to recover, hopefully early part of next year. .

[Operator Instructions] Our next question comes from Eric Wen of Blue Lotus. .

[Foreign Language].

I have 3 questions.

My first question is how much percentage of our total traffic across our product is from content product? And do you expect the revenue potential per -- traffic for the content product to be similar or different from our tools product?.

[Foreign Language].

My second question is that we noticed the competition in overseas market is still very fierce. This quarter, our marketing costs still outstripped our revenue growth.

How does the marketing spending outlook look like in the second half? And what is the effectiveness of our marketing spending in terms of customer acquisition costs, retention rate and average revenue per user?.

[Foreign Language].

And the third question is regarding the mobile game revenue, has been declining.

Can management share some of its thoughts on this business and whether we intend to keep this business?.

[Foreign Language].

Okay. So in terms of the user -- percentage of user traffic coming from our new content products, they are still pretty low right now because it's new compared to our very large user base right now, 600 million. So -- but they also represent very strong opportunity for us to convert a lot of users using those products.

So the MAU -- or the traffic numbers right now is very small. And also, monetization also -- opportunity for content products should be a lot stronger than our utility applications as well. .

[Foreign Language].

In fact, when we looked at the contribution from content product, we can also potentially expand our utility applications on the market as well. So if you can look at it, premium [ph] app example, when we are able to deliver good revenue content to user, we would probably have also that user for our premium [ph] app product user applications. .

[Foreign Language].

Right. I'll give you another example, and we basically have a product named -- called Instanews in India. It's news services. And now it's called News Republic India, and that product actually has a pretty healthy life -- sorry, high spend by user and then if you look at the monetization... .

[Foreign Language].

Monetization is actually much stronger in our user applications in India. It's almost 10x more penetration rate of our content [ph] product over there. .

[Foreign Language].

[Foreign Language].

So when you look at Live.me in the U.S., time spent per user, the active user, is now close to an average 40 minutes per day. .

[Foreign Language].

Right. So when you look at our user acquisition costs for utility applications, I think when -- if you look at -- our spending actually in the quarter is $12 million [ph]. Actually, we have been growing at a pace that is slower than recent quarters both on a GAAP and non-GAAP basis. It's less than 20% year-over-year.

In fact, if you look at on a quarter-on-quarter basis, you may actually see that declining. And that -- and in [indiscernible], we're investing aggressively to promote our new content product. So in fact, we have shifted the marketing dollars from our old utility applications to the new content products.

So I think that speaks volumes to our utility applications' competitiveness and competitive advantage to -- compared to other products from our competitors. Our products themselves are not -- don't have -- we have the user not just because we are promoting our utility application.

So if you look at the development more closely, you actually see that even though we invested heavily on the new products, we actually have been slowing down spending on mobile advertising and also for -- particularly for the older products. .

[Foreign Language].

Okay. So now your third question regarding mobile gaming business or operations, it was really challenging in second quarter for us because Piano Tiles 2 is a very popular game, but it has entered into a more mature stage of its product life cycle. We were really slow to roll out our new game, so Rolling Sky.

That's the casual game that we launched, which came in, in the second half of the second quarter. Right now, it's doing quite well. So we are pretty encouraged by that, and so we look forward to a more steady growth, I mean, in the third quarter. .

[Foreign Language].

[Operator Instructions] This concludes our question-and-answer session. I would now like to turn the conference back over to Helen Zhu for any closing remarks. .

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

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