Evening, and welcome to Meitu's 2017 annual results conference call. I'm Angelina Chen from the IR team. Joining me today to discuss our results are Cai Wensheng, Chairman, Wu Xinhong, CEO, Gary Ngan, CFO, and Bryan Cheng, COO. I would like to take this opportunity to remind you that our remarks today may include certain forward-looking statements. A number of risks and factors beyond our control may cause the actual results to differ materially from those contemplated by these forward-looking statements. During this call, we will present both IFRS and non-IFRS financial measures. We will also discuss general market conditions for our industry, and such information may come from a variety of sources outside of Meitu. For a detailed discussion of the risks factors with these and non-IFRS measures, please refer to our public documents on corp.meitu.com/en/. Now, I'd like to turn the call over to Mr. Cai.
He will present in Chinese, followed by translation.
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Thanks to all the investors for joining our results today.
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We have executed very well on our 2017 plan of laying the foundation of scalable internet monetization, and I'm very proud of our team for working hard to deliver these results. Overall revenues in 2017 have grown 187% year-on-year. In particular, revenues from Internet businesses have grown 652% year-on-year. Importantly, as guided in the IPO, we have delivered on our plans to break even by the end of 2017. Based on unaudited management accounts, we have generated non-IFRS net profit for the last quarter of 2017.
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The monetization infrastructure that we've built over the past year has three key elements: people, data analytics, and brand influence. With that, we are entering 2018 with multiple fast-growing revenue models, which we believe can lead to a step change in profitability in 2019 and beyond.
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I'll now hand over the call to Xinhong to discuss our business strategy. Xinhong is our Chief Executive Officer.
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Thank you, Wensheng. Hi, everyone. I'm Xinhong. 2018 is a special year, and it marks the 10th year since Meitu was founded. It will also mark the year which we embrace the entrepreneurial spirit once more and regard Meitu as a startup again. A lot has changed over the past years, but there are two keywords, beauty and technology, which will remain at the core of what we do for the next 10 years.
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In 2017, we have made significant progress in our Internet monetization. Our revenues from online advertising have increased 409% from a year ago. Advertisers are very excited about being able to display their brands and products to our young, high-quality user base. Within our user base, 81% of them are female.
From an age perspective, 61% of our total users are aged between 18 to 30 years old.
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Additionally, as we have connected all our apps with a unique device identifier system, we are able to help our advertisers to place targeted ads. Our high-quality user base and intelligent advertising system have led to a series of successful campaigns for some of our advertisers generating click-through rates of over 10%. We will continue to leverage on our strengths and launch more advertising products such as News Feed and customized ads in 2018.
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On the Internet Value-Added Services or IVAS side, our strategy is to provide a portfolio of services to satisfy our female users' diverse demand for beauty and entertainment. We had a good year with revenues growing over 985% year-on-year, as our female focused live streaming services have continued to see increased traction. Also, we have observed that female gamers have increased significantly over the past year. We believe a trend of increasing female consumption in online entertainment is underway. In 2018, we intend to expand our IVAS portfolio to include games, online literature, claw crane machines, VIP membership services and more to capture this huge opportunity.
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Thirdly, for our Smart Hardware businesses, the shipment in 2017 was in line with our expectation to reach 1.57 million. The average selling price was higher than what we expected, which has in turn driven a gross margin expansion for this segment in the second half. In 2018, the two major strategies for our Smart Hardware business are: one, increasing our focus on the premium priced T and V series; two, make a foray into beauty related smart hardware and begin to build an ecosystem around beauty.
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Next, I would like to talk a little bit about our user strategy. The primary objective in 2017 was to lay a foundation for future growth in user base and engagement. As such, we have adopted different strategies for different apps in order to better serve the target audience.
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Now let me go through the details of our three core apps. For Meitu, MAU growth remained solid at 14.8% year-on-year in 2017. We believe there is still significant potential to grow our user base by penetrating into lower tier cities. We are also working to transform Meitu into a photo social platform where users can share their interesting lives, follow the latest trends and fashionable content. We expect to launch this upgrade by the end of June this year.
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For BeautyCam, we have adjusted our strategy to focus more on serving the female user group. Although its MAU in December 2017 has declined 23% year-on-year, we believe this is just temporary due to a strategic shift. Importantly, the proportion of female users have increased and their engagement measured in terms of daily time spent, reached a historical high in early 2018.
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For Meipai, in-app MAU have increased 25% year-on-year. In 2017, we have been experimenting with converting the web MAUs into in-app MAUs. This has led to some decline in web MAUs, but has also driven a significant increase in the number of daily video viewed per user, indicating an increase in overall user engagement.
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Some of the apps experienced short-term volatility in their MAU numbers as a result of these adjustments, but all of them were in a much better position strategically entering into 2018. We are very pleased to see that the total MAUs in February 2018 have rebounded to 454.7 million, and we have maintained the number one position in the photo app market in terms of monthly active users.
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Now, I would like to share the two changes in how we run our business. They are AI-driven and data-driven.
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Firstly, it is AI-driven. In 2017, we further integrated our AI technology into various areas of our business, each of which has exhibited promising results. I would like to share four examples.
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First, we have employed AI to develop highly popular app features, such as the Dimensional Camera and Andy the ArtBot in Meitu, as well as Creative Backdrop in Meipai. They have in aggregate generated over 1 billion times of usage, increasing engagement of our users.
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Second, we have launched an AI-based skin detection feature in our e-commerce platform, MeituBeauty, which recommends skincare and cosmetic products according to one's skin condition. Users who have used the skin detection feature showed significantly higher buying conversion and retention rates.
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Third, we are also integrating our AI technology into our smartphone products.
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For example, our proprietary Light Camera, an exclusive feature of the Meitu smartphones, employs AI to reconstruct a 3D model of a user's face and obtain depth information from its surroundings. User can then apply a simulated light source to the photo as if it is being taken in a studio with professional lightings. This creates a highly differentiated experience for our users and sets Meitu smartphone apart from its competitors.
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Finally, our AI was also employed in our video recognition technology, helping us to understand the context of the video that were uploaded to Meipai, such as telling between a street dancer and a ballet dancer. With more insights into our users' behavior and preferences, we can recommend more relevant videos to them based on their interests to increase engagement.
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Secondly, is data-driven. In the second half of 2017, we have also introduced a company-wide initiative to emphasize data analytics in driving many business decisions, such as product design, community management, and marketing.
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Taking Meipai as an example, after increasing the weighting of the algorithmic input in the overall video recommendation mechanism, the number of video views per user per day has increased to an average of 63 compared to 52 in the first half of 2017. These videos' duration usually lasts between 15 seconds to five minutes.
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We've also become a lot more nimble in our product development cycle. With numerous A/B testing results as the guiding principle, we are launching a new update version for most of our apps every week. We are also aggressively building up our unified account base, which will help us to gain deeper insights of our users' behavior, as well as serving as a foundation for launching services across different apps.
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As of the end of 2017, we had 267 million of accumulated MTID, representing 33.5% increase from June 30th, 2017.
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In our view, AI is a very important trend going forward. AI will help us tremendously in providing more personalized service to our user in the future.
We believe these two changes will lead to a significant user growth in 2018.
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Now let me turn to Gary for a discussion of business and financial results. Thank you.
Thank you, Xinhong. I will first focus on discussing the revenue performance in the second half of 2017, as they will give you a sense of how fast our business is growing. Total revenues in the second half of 2017 were CNY 2.35 billion, up 136% year-on-year. In particular, revenues from the Internet businesses were CNY 541 million, up 611% year-on-year. Our Internet businesses in the second half of 2017 accounted for 23% of total revenues, whereas 18 months ago, in the first half of 2016, it only accounted for 5% of total revenues. This represents very significant growth, but we believe this is just an early beginning of a very scalable business.
Our confidence is now stronger with Bryan Cheng joining us as Chief Operating Officer, as he brought over many years of experience in building various monetization model from scratch at Weibo as their Senior Vice President. Advertising revenues in the second half of 2017 were CNY 225 million, grew 558% year-on-year, and 172% sequentially compared to first half of 2017. As we previously mentioned during our IPO, our advertising revenues in 2016 were mainly limited by the size of our advertising team. In December 2016, the entire advertising department consists of only 23 people. By the end of 2017, we have built a team of 166 people, which includes salesmen, engineers, product managers, ad planners, and designers. The expanded team size enable us to serve more than four times the key account clients or brand advertisers in the second half of 2017 compared to a year ago.
Additionally, we are expanding our advertising product offerings, such as audience targeting, programmatic sales, and new formats such as News Feed. We believe these measures will underpin our advertising growth due to an expansion of our ad inventory, increasing the sell-through rate of our ads, and increasing the per-advertiser spend as the campaigns became more efficient. For our IVAS and other business, revenues in the second half of 2017 were CNY 316 million, grew 661% year-on-year, and 92% sequentially compared to the first half of 2017. Virtual item sales from Meipai live streaming accounted for the vast majority of this segment. Average monthly paying users were 313,000 in 2017. We want to emphasize that live streaming is only one of the many internet value-added services that we will provide to our users.
In 2018, we will be expanding that portfolio to include games, VIP membership services, online literature, claw crane machines, and so on. From a traffic monetization perspective, live streaming in 2017 was monetizing only about 25% of the 29.5 million in-app MAUs of Meipai. The upcoming IVAS that we are launching will utilize the broader traffic of Meitu's product matrix, which is more than 10 times the size of the user base of our live streaming services. We expect revenues from IVAS to grow rapidly in 2018, driven mainly by the increasing number of paying users. However, we do expect ARPU to reduce as many of the IVAS that we are launching in 2018 will carry a lower ARPU compared to live streaming. Our e-commerce platform, MeituBeauty, was officially launched in late October 2017.
Although its revenue contribution was insignificant, it has shown some really encouraging operational metrics, such as an average ticket size of over CNY 400 and close to 60% of the sales were contributed by repeat customers. Our vision for MeituBeauty is to provide our user with the most personalized skincare and cosmetic products through AI. At this stage, we are still prioritizing the optimization of user experience over maximizing GMV. For our Smart Hardware business, revenues in the second half of 2017 were CNY 1.8 billion , grew 97% year-on-year, and decreased 7% sequentially compared to the first half of 2017. We sold approximately 728,000 units in the second half and a total of 1.57 million for the full year of 2017.
This is ahead of the 1.5 million units guidance that we have given out during the IPO. Looking ahead, we are expecting to launch two new models of the higher priced T and V series in 2018. We are temporarily suspending our mass market N series to make way for our beauty related smart hardware, which we expect to launch two products in 2018. As a result, we expect the 2018 revenue growth in the Smart Hardware segment to be driven primarily by ASP expansion and to a less extent, the number of phone units sold. Now let me turn to some full year profitability metrics. Gross profit increased by 336.7% to CNY 1.044 billion in 2017 from CNY 239.2 million in 2016. Overall gross margin increased to 23.1% in 2017, up from 15.2% in 2016.
Gross margin of our Internet business segment was 23.5% in 2017, compared to a gross loss margin of 55.1% in 2016. Expansion of gross margin was mainly due to the rapid growth in revenues and associated operating leverage. Gross margin for our Smart Hardware segment was 23% in 2017, compared to 20.1% in 2016. This margin expansion is mainly due to increased revenue contribution from the higher priced T and V series model within the product mix. Now moving down to income statement. The primary driver for growth in operating expenses was personnel related costs and to a less extent, marketing and promotional expenses. We had a net addition of 738 employees in 2017, mostly related to engineering, product development, and monetization. Excluding share-based compensation, sales and marketing, research and development, and administrative expenses account for 13%, 9.2%, and 3.7% of revenues in 2017, respectively.
As our revenues were growing much faster than our cost base, our adjusted net loss has narrowed significantly to CNY 46.9 million in 2017 compared to CNY 540.5 million in 2016. Based on the unaudited management account, we have turned profitable in the fourth quarter of 2017 on an adjusted non-IFRS basis. Our capital expenditure in 2017 was CNY 54.8 million , mainly related to server and computer equipment. We expect CapEx to increase in 2018 as we are expanding our infrastructure capacity for growth in both active user base and engagement. As of 31st of December 2017, our cash position was CNY 5.17 billion , and we do not have any debt. With that, I will turn the call back to the operator to open up for questions. Operator?
We now begin our question and answer session. If you have questions for today's speaker, please press zero one on your telephone keypad and you will enter the queue. After you are announced, please ask your question. If you find your question has been answered before it is your turn to speak, please press zero two to cancel the question. Once again, please press zero one on your telephone keypad to ask a question. The first question is from Alicia Yap at Citigroup. Your line is open. Please go ahead.
Hi. Good evening, management. Thanks for taking my questions. I have two questions. Number one is regarding your initiative to transform Meitu into the photo social platform. How are you going to have the differentiated social networking features? How do you differentiate yourself versus other social networking products in the market? So far, what is the feedback? Second question is regarding the live streaming. I understand you have a lot more female centric user base. How are you going to grow in terms of the business model with such a bigger groups on the female user base versus the other live streaming platform? Thank you.
Okay. Let me just translate the question to the management team first.
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The idea of creating a social network based on Meitu is very much driven by the demand from our users. There's frankly not a lot of choices of social networks in China, and some of the demands can't really be satisfied by the current choices. We do see a lot of users very willing to share their lives and share their photos on Meitu, and that's why we want to create this social platform. Right now we're in the status of closed beta. I cannot really disclose the detailed figures, but in terms of trend, they are very positive on a daily basis.
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This is Bryan Cheng. About live streaming, currently our pool for the live streaming user is pretty good, and we are seeing a huge potential for the upgoing of the numbers in terms of the number of female users. Most of the live streaming broadcasters are females already, and we have a very good ratio in terms of audience between the female and male audience. Going forward, we are adding more live streaming broadcasters with a special skill, for example, singing or dancing, to attract more female users alongside male users. Does that answer the question?
Yes. I think just to follow up a bit on it, I understand you guys will be launching games and literature and other service, kind of complementing the live streaming. How important will live streaming among the overall Internet Services in the future?
Okay. Live streaming will be serving as gravity of the user base. Using the live streaming, we will be able to filter out the high output users, and then we can transfer those users to literature readers group and to other value-added services.
I see. Okay, got it. Thank you so much.
Sure.
Next question, please.
From Xing Chen at CCBI, please go ahead.
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Okay. Xingchen, do you want to translate the question into English or got it?
Sure. My question is about advertising. Among the CNY 300 million advertising revenue, how much does Meipai's contribution among this? Also, among the overseas, have we started monetization for the overseas advertising users? If not so, what's the timeline for that? Also, the last bit is, do we have a number for the top three customers' contribution for advertising? Or top one or top five? Any color would be helpful. Thank you.
This is Bryan. In terms of Meipai's contribution to overall ads revenue, at the current moment we don't have exact numbers, but in terms of ratio, in terms of percentage, it has a huge potential for the future because the short video market is growing rapidly. But currently, it has a small percentage in terms of ads revenue. In terms of overseas revenue potential, we're still at a stage of growing our user base currently, and we are monetizing portion of our overseas user via working with Facebook and Google. Going forward, we're seeing huge potential for the overseas user monetization in the future, next few years.
In terms of seasonality, I think most of the time
First quarter is going to be a little bit slower. Then second quarter is probably starting to be better. But I think seasonality for us right now, it's important, but because the overall revenue growth is actually very fast, you wouldn't see the normal seasonality in the sense that, oh, you will see first quarter, it will be lower, and then second quarter and third quarter will be similar. We're not seeing that. I think the trend of increasing revenue will still be more prominent than the seasonality effect.
Thank you.
Next question, please.
Next question is from Thomas Chung at Credit Suisse. Your line is open, please go ahead.
Hi. Thanks, management, for taking my questions. I have three questions. The first question is about our advertising business. Given we are seeing the monthly run rate continues to increase since 2017, what are the feedback from the brands? Why they keep on allocating more and more budget on our platform, and how we should think about our AI compared to other applications? That's the first one. My second question is about short video. Can management comment about the competitive landscape right now, and should we expect there will be a step up in sales and marketing expenses going into the future? My third question is about the step change in terms of the profitability in 2019. Is there any color about the margin trend that we should think about in the next couple of years? Thank you.
Yeah. Let me take the first question. This is Bryan. In the last one year, we have lots of advertising coming into our platform, especially cosmetic and fast consumer products, those two verticals. We are seeing huge interest for the big advertisers, big advertisers and small and medium-sized advertisers as well. Those are the cosmetic. Going forward, cosmetic, fast consumer products, and other verticals which are targeting the female users who are seeing those as our potential big spender for advertising.
In terms of the sales and marketing, I think, in 2018, we are going to obviously increase the sales and marketing expenses. Overall, we are not expecting the sales and marketing as a percentage of revenue to change significantly compared to 2017. I think for the third question regarding the step change in profitability, I think we will have to understand it in a couple different drivers. First of all, as advertising continues to grow, it actually carries a very high gross margin. I think advertising is easily over 70%. Even if you allocate all the server and bandwidth cost to advertising, it is still over 70%. That will actually drive margin at a growth level to continue to expand.
The second thing is, because we already have such a large user base, the expenses, as we have discussed in the call earlier, will be driven majority by personnel cost. If you look at the revenue growth and put that side to side against our personnel-related cost growth, personnel cost growth cannot be growing that fast compared to revenue. That is why we are expecting the gross margin will continue to expand as our revenue continue to grow, especially when the revenue growth is coming from advertising. Now, I do not want to give a specific guidance in terms of numbers, but I think you should focus more on the operating leverage coming out of our business. I think one very key differentiator for Meitu is we already have built the user base, and that is usually the highest drain on expenses for most other internet companies.
Whereas for us, we have already got that user base and the upcoming costs or expenses are mostly related to people.
Thank you.
Next question, please.
Our next question is from Wesley Lee at Gold Mountains Asset Management. Please proceed.
Hi. Hello?
Hello.
Oh, thank you. Thank you for taking my call. Congratulations for your result in 2017. I have several questions regarding your result, because I just look at the announcement. You reported adjusted net loss is about CNY 15 million, but the reported net loss is about CNY 200 million. Can you tell me what are the extraordinary items that is included? Last year, Chairman Cai Wensheng did some buyback in the market. I wonder if the company have any plan for some share buyback or any management officers will have any plan to buy the shares. Last question is about the pre-IPO shareholders. Any discussion among the pre-IPO shareholders regarding their plan? Thank you very much.
Okay. Let me just take the first question. In fact, if you look at our announcement, there is a specific session that talks about how the adjusted net loss reconciles to the overall headline loss. You should refer to page 11 of our announcement. I think, just to give you a quick sense, the difference is mostly related to share-based compensation and, to a less extent, the net fair value gain or loss related to our long-term investments. That is the first question.
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Maybe I will first speak on behalf of the company to talk about the share buyback. I think we will consider that when there is the right timing and opportunity and right price. It is our goal to return excess cash to shareholder, but I think right now we are at a point of growing our business.
I think at this point in time, our cash will be deployed more to growing the business, which we think will generate better overall long-term shareholder value. We would not rule out the possibility to do share buyback.
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At that point, I personally think that the share is quite undervalued. That is why I have purchased in the open market. I would not rule out the possibility to do that again when the opportunity arises. As of today, we do not have any concrete plans to do it.
Okay.
Would you mind to repeat your question? The third question.
Yeah. I have another question, sir, about your write-down of your products. Last year you write down CNY 33 million . May I know the reason behind it? Do you see any write-down in this year?
Okay. So actually, if you look at our 2017, we have written down CNY 72 million, and then it was offset by a gain on disposal of about CNY 32 million. We have invested a lot of different early-stage businesses, which we think will be complementary to our overall business, as well as building an ecosystem around beauty. Obviously, all of these are very early-stage investment, and they are very risky. I think we will control our risk exposure in terms of the size of the investment. But all in all, I think a lot of investment that we make are very promising, and they are very complementary to our business. Again, we have already do what we should have done in our 2017 results.
We don't have any current plans to write up or write down investment, but depending on the performance of these investment, and also depends on whether they will have a mixed round of financing, we will measure the fair value every time we announce our results.
Okay. Thank you very much.
Next question, please.
Our next question is from Jeff Hao at Milestone Asset Management. Please go ahead.
Hi. Thank you for taking my question, and congratulations for your good results. I have two questions. The first is about competition. Can the management give some comments and your views on the competition with Douyin? Because do you see any threats from Douyin in terms of user time spent, particularly compared with your Meipai app? Because if I am correct, the Douyin's user profile and the content offering in terms of type of contents are quite similar. That is my first question. My second question is about your user acquisition strategy. Maybe can you give us some color on how would you acquire new users, and can we expect your MAU to start to grow this year and maybe next year? Thank you.
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So we actually think that the positioning for Douyin and Meipai is quite different. Douyin is a little bit more related to funny videos and overall entertainment, whereas Meipai is more focused on the different vertical interests of the female user group. We are also going to build a lot of content around these various interests of female users, and we will also integrate or do mutual content exports, so to speak, among the apps of the entire Meitu user product matrix. The two positioning of Meipai right now is to have very good-looking people on Meipai, and also the videos are very fun to watch.
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The other observation that we want to make here is we believe a lot of demand from female in terms of short-form videos has not been very well satisfied. In fact, a lot of short-form video platforms today are supplying male-related content. We do think there is a strong value proposition for Meipai.
We also note that the interest of female in the first and second-tier cities is actually very similar to that of lower-tier cities. They all would like to watch similar fashion content, so on and so forth. That actually is a very good opportunity for Meipai to continue to penetrate into cities other than first and second-tier cities. In terms of the user acquisition strategy, I want to say that we do expect MAU to grow. In fact, if you look at the February MAU numbers, already back to 454 million, which is again very substantial increase from December last year. I think as usual, our strategy is going to be a mix of organic and paid marketing. Most of our user growth will be driven by organic traffic. I think delivering good products is one of the key ways to grow our user base.
Thank you. Thank you, Gary.
Many thanks for joining us today. We appreciate your time, and we look forward to speaking with you again.