Hello Group Inc. (MOMO) Q3 2016 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the Third Quarter 2016 Momo Incorporated Earnings Conference Call. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. [Operator Instructions] I must advice you that this call is being recorded today November 8, 2016. I would now like to hand the conference over to your first speaker today, Ms. Cathy Peng. Thank you, please go ahead.

Thank you, operator. Hello everyone, and thank you for joining us today for Momo’s third quarter 2016 earnings conference call. The Company’s results were released earlier today and are available on the Company’s IR website. On the call today from Momo are Mr. Tang Yan, Co-Founder, Chairman and Chief Executive Officer; and Mr. Jonathan Zhang, Chief Financial Officer. Mr. Tang will discuss Momo’s business operations and company highlights followed by Mr. Zhang who will go through the financials and guidance. They will all be available to answer your questions during the Q&A session that follows. Before we begin, I would like to remind you that this call may contain forward-looking statements made under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements are based on management’s current expectations and current market and operating conditions and relate to events that involve known or unknown risks, uncertainties, and other factors, all of which are difficult to predict and many of which are beyond the Company’s control, which may cause the Company’s actual results, performance, or achievements to differ materially from those in the forward-looking statements. Further information regarding these and other risks, uncertainties, and factors is included in the Company’s filings with the U.S. Securities and Exchange Commission. The company does not undertake any obligation to update any forward-looking statement as a result of new information, future events or otherwise, except as required under law. I will now pass the call over to Mr. Tang. I would translate for him. Mr. Tang, please.

[Foreign Language] Good morning and good evening, everyone. Thanks for joining our conference call today. From a high level, Q3 2016 was a remarkable quarter for us, with achievements on product innovations, business operations, as well as financial results. Total revenues for the quarter reached $167 million, up 319% year-over-year. With the strong operating leverage in our business model, the following top-line performance has brought significant bottom-line expansion. For the third quarter of 2016, non-GAAP net income reached $49.5 million, growing more than 11-fold from the year-ago period. [Foreign Language] Now, quickly, on the operating metrics, total MAUs on the Momo platform reached 77.4 million for the quarter, compared with 73 million a year ago, and 74.8 million for the previous quarter. The total MAUs we are disclosing here does not include the active users on our stand-alone live-streaming application Hani, which achieved close to 1 million MAUs in September. As most of the live broadcasting activities happen within the Momo application, instead of on Hani, we will not be separately disclosing the user metrics for Hani until it reaches the next milestone. Neither are we going to count it into the platform MAU that we disclose on a quarterly basis. [Foreign Language] For those investors who are relatively new to our story, I wanted to take a few minutes on this call to share some of my strategic thinking about Momo. [Foreign Language] User growth stays on top of our agenda. I believe the most effective way to keep expanding our user base is through continuous product innovations, and expanding the core use cases. During the past five years, Momo has evolved from a simple location-based feature that helps people discover new relationships to a platform that accommodates a variety of different social and entertainment use cases, including one-to-one communications, group chatting, postings in various formats, and most recently, live broadcasting and short videos. It is fair to say that Momo was built through a series of efforts to add on new features and functionalities in order to push the boundaries of our core use cases and satisfy new user demand. That is still going to be the direction that we head down in the future. My long-term vision for Momo is for it to play an important role in China’s social and entertainment industry. We will continue to branch out from our core strengths, and explore in different territories in order to get there. [Foreign Language] More specifically, our near to mid-term product initiatives will revolve around the convergence of video and social activities. Enabled by technological transitions, we believe video is fundamentally changing the way people, especially young people, socialize and have fun via the Internet. The success that we have accomplished in the live broadcasting space positions us well to keep pushing deeper into other territories in the video, social, and the broader entertainment industries. By deeply integrating video elements into every major social scenarios on Momo and providing more entertaining content to our users, we could substantially broaden the core use cases on Momo and raise the ceilings of our total addressable audience. [Foreign Language] With that, I’m going to dig deeper into the quarter, and review the progress we have made against that strategic framework. In August, we launched a major update version, Momo 7.0. As mentioned earlier, the whole 7 series was centered on the integration of video into other core product modules on Momo. In the 7.0 version, we introduced our interactive short video service called Shike, or Moments, in English. The service enabled our customers to create short video stories of up to 10 seconds, and add speakers, emoticons, on-screen messages, as well as doodles. This service aims at providing the young people on our platform with richer and three-dimensional self-expression tools, and delivering a more interesting video and social experience. The viewers are able to interact with the video creator by leaving messages, liking the content, or sending virtual gifts. The video stories remain viewable for up to 24 hours, by the author’s followers and nearby people. In a subsequent update, on September 30th, we injected augmented reality elements into the feature and added more fun lenses, supported by face-recognition technology. In that same upgraded version, we also launched a brand new stream of feeds aggregating all of the video stories posted by nearby people. With these two updates, the number of daily uploads and the videos viewed has grown substantially for Moments, during the month of October. More importantly, we’re happy to see that more and more users on our platform are realizing that video, as compared to text and picture-based content, provides a much more compelling and immersive social experience. In the next few updates, we will consider digging Shike out from the secondary page and presenting it at a more prominent location within our app. And by doing that, we are promoting a new, and in a lot of ways, more effective way to interact and socialize on Momo. At the same time, we are also providing a powerful tool for the top broadcasters on our platform to expand and engage with their fan base. Operational-wise, we are systematically building out a motivation and recommendation mechanism to drive more quality content into the system. As mentioned earlier, video is the core to our mission. It will enable us to break the boundaries of our existing offerings and build Momo into a bigger platform for users to socialize and have fun in a broader sense. [Foreign Language] For the live broadcasting service, we are also taking strides to make our product and service better. During the quarter, we have refined our traffic dispatching mechanism in order to drive a more scalable and healthy revenue distribution model among the broadcasters. As a result of that effort, the revenue concentration in the very top-tier performers kept going down, while an increasing number of talented performers are able to build a sizable audience, as well as meaningful income on our platform. Other than the improvements in traffic allocation algorithm, we’ve also rolled out a number of new features and gamifications to drive better user experience and monetization efficiency. Just a few examples here. During the quarter, we introduced [indiscernible], or connected channels to iOS users. With this function, broadcasters can invite other users into their channel, and the viewers can see two broadcasters interacting with each other. This feature opens up the opportunities to bring more interactive gamifications into our live-streaming service. Other than this, we’ve also introduced some interesting interactive virtual gifts on the back of the face recognition and AR technology. For example, for only RMB9.9, the users can send animated cat ears and attach them to the broadcaster’s head, which offers a fun, interactive experience between the broadcaster and the viewer. In addition, we have also refined the ranking system by adding the hourly meters board in order to better motivate the performers. These product initiatives have contributed significantly to the growth in engagements, as well as monetization of our live-streaming business. [Foreign Language] Now, moving on to business review. [Foreign Language] Live broadcasting business, our number-one revenue engine, continued to gain traction in the third quarter, with total revenues reaching $108.6 million, up 88%, from the previous quarter. Now, I am going to quickly run through the underlying drivers and how we are managing the growth of this business. In September, live broadcasting service covered around 20% of the DA user platform, up from 13% three months ago. We believe this conversion ratio still has potential to go further up, due to the high compatibility between the mentality of Momo users and live broadcasting. In order to drive the conversion ratio higher, there are a number of things that we are working hard on. Other than the product and operational efforts that I mentioned earlier, we are also focused on improving the technologies to reduce the latency in loading, and more importantly, building an ecosystem to motivate the top performers and agencies to broaden the content variety and improve content quality. At the same time, we are also testing different algorithms to service more live-streaming content onto the nearby people list in order to speed up the conversion process. We are taking this initiative carefully to make sure we get the algorithm right to have a positive impact on both live broadcasting business, as well as the overall user experience with the nearby people list, which is currently the biggest use case on our platform. As a supplement to these endeavors, we are also working with the telecom carriers to reduce the fees for our users to stream live video content on Momo. We recently partnered with UNICOM and rolled out a data package specifically for consuming video content on Momo. This package substantially reduces the cost for the subscribers to stream live content on our platform. Both UNICOM and we are happy with the initial feedback from the market. We plan to deepen these type of collaborations with UNICOM, and potentially, with other operators, to further drive the penetration rate of video conferencing consumption on Momo. [Foreign Language] Once we board the users to live broadcasting service, we have plenty of operational efforts that have been proven effective by other industry players to drive the paying ratio and average revenues per paying user, or ARPPUs. We are tactfully controlling the gas pedal in order to balance user experience while continuing to drive monetization. [Foreign Language] Now, moving on to mobile marketing business, during the third quarter, our mobile marketing business continued to generate healthy growth. During the past several quarters, effective CPM, or eCPM, has been a key driving force for our online marking business. We have already tested a few campaigns with the new video app format, as well as the in-feed ad unit for brand marketers. Based on the positive feedback, we received from these piloted campaigns, we believe eCPMs will continue to be a meaningful driver for our future growth in the online marketing sector. In addition, we are also seeing emerging marketing demand from individuals and businesses in connection with the live video opportunities. We are currently exploring various ideas and formats in this pioneering space, and will keep you posted on our progresses. [Foreign Language] Moving on to mobile gaming, mobile gaming is an important way for young people to socialize and have fun via the Internet, and is also a crucial piece in our strategy. Where we are today in mobile gaming is far from where we can be and where we need to be in this space. During the past couple of quarters, we have been scaling back from the jointly operating and publishing model and refocusing on self-developed or tailor-made games that are deeply connected to the social and LBS attributes of the Momo platform. Although that could cause the near-term revenue growth to slow down, we believe that from a long-term strategic level, it is the right direction for us to move toward. [Foreign Language] Now, briefly on our membership business. During the third quarter, membership business continued to generate healthy growth, driven by both the number of members and the ARPU. However, as more and more people start to pay for value-added services through our live broadcasting and short video services, we will consider not to roll out new privileges too aggressively, and instead, leave some of the special features to non-paying users. We believe that is helpful to enhance the overall user experience on our platform. [Foreign Language] Overall, I am very satisfied with the progresses that we made in nearly all major aspects of business execution during the third quarter. We will continue to deliver to our shareholders against our strategic priorities. With that, I would like to turn the call over to Jonathan for a financial review. John, please go ahead.

Thanks, Tang Yan and Cathy. Good morning and good evening, everyone. Thanks for joining our conference call today. The third quarter of 2016 was quite a successful quarter for us. We posted top-line results that far exceeded our internal expectations. Total net revenues grew by 319% year-over-year to $157 million, higher than our earlier guided range of $125 million to $130 million. Benefited from continued growth in our revenues, our highly scaled efficient business model resulted in a record-level profitability for the third quarter. Non-GAAP net income was $49.5 million for the quarter, compared to $3.9 million in the same period last year. Now looking to the key revenue items, in the third quarter of 2016, revenue from live video service continued its strong growth momentum, reaching $108.6 million, up 88% sequentially. Paying users for the third quarter of 2016 reached 2.6 million, compared to 1.3 million for the previous quarter. Average revenue per paying user, or the ARPPU for the quarter, before excluding value-added tax, was RMB296, slightly down from RMB301 for the second quarter 2016, due to the developing long-tail effect. In the third quarter, live video service covered around 20% of our total daily active users of the platform, compared with about 13% a quarter ago. Just as Tanzo mentioned earlier, as we continue to optimize user experience and drive richer content for the live broadcasting service, we believe there is ample room for us for further grow this business. Revenue from mobile marketing was $17.7 million, up 64% from $10.8 million, for the third quarter of 2015. The year-over-year growth was mainly powered by the increase in effective CPMs, as well as better sell-through of our ad inventories, which was, in turn, driven by the strong demand from the marketers across different sectors. As many of you have already seen, we started testing new video app formats in the in-feed ad unit recently. We expect eCPM to continue to be a major driving factor to the future growth of our mobile marketing business. At the same time, as we get ready to penetrate deeper into the brand marketing space, the increase of sell-through rate of our brand-oriented ad inventories will be another meaningful contributor to the growth of our marketing business in the coming quarters. Mobile games revenue was $9.3 million in the third quarter 2016, slightly down from $9.5 million a year ago. The year-over-year decrease was as a result of our decision to scale back from the jointly operating and publishing model to refocus on the self-developed and customized games. This trend could continue into the coming few quarters, until our new gaming strategy starts to take effect. Membership subscriptions revenue was $18.1 million, up 13% from the same period last year. The growth was driven by both the increase in the number of paying users, as well as the increase in ARPPU, which was due to the S-VIP subscribers growing as a percentage of total paying members. Paying members totaled 3.4 million as of September 30, 2016, up from 3.3 million a year ago. Now some quick highlights on the costs and expenses area. For the third quarter 2016, our cost and expenses on the non-GAAP basis totaled $109.5 million compared to $35.4 million for the same period last year. The year-over-year increase in cost of revenue was primarily attributed to our scaled expansion, especially the booming live video services. The biggest cost driver was the revenue sharing with the live broadcasters, then followed by the payment channel costs. These items were proportionate to the revenue growth of our live broadcasting business. During the third quarter, our bandwidth-related cost including IDC, CDM, and messaging services, declined significantly as a percentage of revenue, both on a year-over-year basis, and sequentially. On the operating expenses, we executed our operations during the quarter, according to the operating budget set at the beginning of the quarter diligently. Our scale-efficient business model turned in substantial leverage effect across all three operating expenses line items. We continue to invest in branding initiatives, the expansion of our marketing channels for new user acquisitions, and promotional efforts on live-streaming business. Even with step up these efforts, non-GAAP selling and marketing expenses as a percentage of revenue, dropped to 18% in the third quarter from 47% a year ago, and 25% in the previous quarter. It is worthwhile to mention that by the end of September 2016, our total number of employees was 800 compared to 784 a year ago, and almost the same as of June quarter end. Expenditures related to human capital remain as our second largest component in our overall cost and expenses. We will continue to stick to our FX light and operating-efficient business model going forward. Based on the above-mentioned, our non-GAAP net income attributable to Momo Inc. was $49.5 million in the third quarter 2016, representing a net margin of 31.5% compared to $3.9 million, or 10.3% in the same period last year. I would like to remind our investors that our margin profile may fluctuate from period to period, as our product and business are still at a developing stage. Future investments in product developments, user expansion, content enrichment, along with the seasonality in our business, may have significant impact on our financial metrics. Now, quickly on the key balance sheet and cash flow items, as of September 30, 2016, we have cash, cash equivalents, and term deposits totaled $560.6 million compared to $469.5 million, as of December 31, 2015. Around 68% of our cash balance was deposited offshore in U.S. dollars as of December 31, 2016, compared to 87% a year ago. Such a change was because that all of our cash generated from operations is in RMB. As we continue to generate positive cash flow going forward, this trend is expected to continue. Net cash provided by operating activities in the third quarter of 2016 was $62.9 million compared to $7.5 million for the same quarter in 2015. Then it comes to our fourth quarter guidance. For the fourth quarter of 2016, we expect our total net revenue to come in the range from $185 million to $190 million, which translates into a year-on-year growth rate from 369% to 381%. Please be mindful that the revenue estimates reflect the Company’s current and preliminary view, which is subject to possible material changes not known at this moment. In addition, we would like to remind you that the estimated range reflects our current assumption on the foreign exchange rate. As our reporting currency is in U.S. dollar, and substantially all of our revenues are denominated in Chinese yen, stronger-than-expected currency headwind could have negative impact on our performance against the guided range. With that, I would like to conclude the prepared remarks for the call and to turn the call over to Cathy to start the Q&A session. Cathy, please.

Well, actually, just quickly one thing before Q&A, for those who can speak Chinese, please translate your question into Chinese by yourself. That would help us to ensure the quality of translation to the largest extent. With that, operator, we are ready for Q&A. Please open the lines.

Thank you. Ladies and gentlemen we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from the line of Claire Chow of Morgan Stanley. Please ask your question.

Hi, management, and thanks for taking my question and congratulations on the strong quarter. My question is related to the revenue concentration level of top-paying users for our live broadcasting business. So just want to have an update on that number. And my second question is, do we have any more plan on our REN advertising spending for the user acquisition? Or any other plans for more content investment in the coming quarters? [Foreign Language]

[Foreign Language]

Can I quickly interrupt? Allow me to translate first.

Well, Claire, on your question about the revenue concentration on the broadcasters as well as the high-paying users, in the months of September, if we look at the top-layer performers, or the top-layer broadcasters, for those broadcasters who can bring in more than RMB30,000 on a monthly basis, these are usually the group of broadcasters who are taking this as a profession. We would call them professional broadcasters. In terms of revenue contribution, they – this group of broadcasters represent from 40% to 50%, a little bit less than half of our total revenues generated from live broadcasting service. So that is the top layer of the pyramid. If you look at the bottom layer of the pyramid, if we look at the broadcasters who bring in less than RMB1,000 per person per month, we have, in the month of September, 400,000, these type of broadcasters on the platform. This is a group of people who are really just taking live broadcasting as a better way to socialize and have fun on Momo. These are part of our existing Momo users who are on the platform to socialize. So this is the situation for the revenue concentration among the performers. In terms of the revenue concentration among the high-paying users, also in the month of September, if you look at the high-paying users, or whales, as somebody called them, for those paying users who have spent more than RMB5,000 per month, in September, we have – sorry, close to 10,000 of these type of high-paying users, and they represent also around half of the total revenues generated from the platform. [Foreign Language] Okay. In terms of your question on brand advertising, in the third quarter, we did run a major branding campaign to drive user growth. Actually, during the first three quarters in the year 2016, we run different kinds of branding campaign to push the users. And in the fourth quarter, we have such plan on the branding side as well. However, if you look at how we have been growing our users during the past five years, product innovation has been the major driver, or the key channel, how we continue to drive the user growth and expand our user base. I think that is still going to be the case down the road.

That is very helpful. Thanks, Tanzo and Cathy.

Operator, we ready for next.

Thank you. The next question comes from the line of Zoe Jau of Credit Suisse. Please ask your question.

Hi, management. Congratulations on a very strong quarter. I have two questions. First of all, could you share with us the DAU over MAU trend in the past three months, especially after the launch of the new video products? And number two, could management give us some colors on the apple-to-apple base, like paying ratio? For example, could management share with us MAU watching live streaming videos, so that we can better compare? Yes. [Foreign Language]

[Foreign Language] In terms of the DAU/MAU ratio, it actually has been pretty stable over the past period of time, as we haven’t really been providing DAU numbers, so we hesitate to disclose an absolute amount here for the ratio. On your question about the MAU, watching live broadcasting, using live broadcasting service, again, we haven’t really been disclosing that number regularly to the investor community, so I don’t really have an answer on that question either.

Zoe, any other questions?

Yes, thank you for the colors. Maybe just another question. We noticed there are more activity from the platforms, such as the competitions and the unions among the anchors. Just a question on how to balance the top host versus the ordinary host. [Foreign Language]

[Foreign Language]

[Foreign Language]

[Foreign Language] Yes, I am going to talk about the general direction that – general policy that we have in terms of traffic dispatching and allocation. [Foreign Language] In terms of the recommendation tab, the recommendation page on the live broadcasting tab, we tend to use that page to push more talented new performers instead of pushing the top-layer performers, who already have a sizable audience base. [Foreign Language] And then we, other than the recommendation page on the live broadcasting tab, we also have the nearby tab, nearby page, on the live broadcasting tab, which is very unique to Momo. And we are using that page, that nearby page, to push more new live broadcasters, as well as, you can call them more long-tail kind of live broadcasters who are just taking Momo as a way to socialize. [Foreign Language] Momo Live, as you mentioned just now, is our official professionally produced content. It is for the top-tier talented performer to be put in front of a bigger audience. [Foreign Language] In terms of the different competition that, or the different kind of events that we are running, it’s more leaning towards a very, very top layered performers, to drive the performance as them and make them more famous.

Zoe, does that answer your question?

Yes, thank you, management.

Great. Operator, let’s move to next.

Thank you. Your next question comes from the line of Alex Yao from JPMorgan. Please ask your question.

[Foreign Language] Congratulations Mr. Tang Yan and Jonathan. My quick question is about the [indiscernible] of live broadcasting after two quarters of nice run. Specifically, take the six to eight quarters view, what do you guys do to further drive the monetization of the live broadcasting? And then second question is on the investment and the spending sides. Over the next 6 to 12 months, what are the key investments, initiatives that you have got in mind? Thank you.

[Foreign Language] So your first question is about where we are in terms of how deeply we dig into the monetization opportunities around the live broadcasting service. [Foreign Language] My view is that – I’m going to break that down into four major drivers to review the performance of the growth potential of the live broadcasting service. [Foreign Language] The first driver is obviously the total DAUs of the Momo platform. And the second driver is out of that total user base, how much we can convert into the live broadcasting feature. And the third driver is the paying ratio, how much of the – how many of the total live broadcasting users actually pay. And the fourth driver is average, revenue per paying user, or ARPPU. [Foreign Language] Well, firstly, let’s look at the conversion ratio. In June, in the month of June, live broadcasting feature covered 13% of our total DAU. In September, that number went up to 20%. Based on our observation, because the high level of compatibility between the Momo user’s mentality and the mentality required for consuming live broadcasting content, we believe there should be ample room for us to further drive that conversion ratio. [Foreign Language] In terms of paying ratio, during the second quarter, we had 1.3 million paying users for live broadcasting service. In the third quarter, that number went up to 2.6 million. In terms of where we are in terms of driving the paying ratio, we believe we are still at a pretty early stage. [Foreign Language] In terms of ARPPU, because our live broadcasting service has been around our platform for only a short period of time, for only six months, we haven’t really been very aggressive rolling out the operational efforts. Other than the monthly Hani starts event that we have been running for several months, we haven’t really been active in other kind of operational efforts that we could have put in there. So pretty ample room on that front as well. [Foreign Language] Well, lastly, let’s look at the first driver, which is the total user base of the Momo platform. During the past three quarters, I would describe our user trend as on a pretty stable rebounding and growth phase. [Foreign Language] So I think the user growth will follow the product innovations and the expansion of the core use phases on the platform. After our – we feel comfortable with that, there is a substantial improvement on the product side, and on the use case side, we will step up our efforts on marketing, both branding and paid marketing channel in order to let that market and let the users know that there are new things on Momo. And that’s when we’re going to see bigger growth in the user base as Momo. So if you look at holistically on those four drivers, for live broadcasting business, we believe that we are still at a pretty early stage in terms of further driving the revenue from live broadcasting business.

I think we are running – we are already running out of time. With that, we are ready to conclude the call. I will hand back to the operator. Thank you, everyone, for joining us this quarter. We will see you next quarter. Bye.

Thank you. Ladies and gentlemen, that does conclude your conference for today. Thank you for participating and you may all disconnect.

Operator? Operator?

Yes.

Well. Actually, we have the second part of Alex’s question that hadn’t been addressed. I apologize for that. I will hand it back to Jonathan to answer the second question.

Hey, Alex, this is Jonathan. Let me just take your second question quickly. As I mentioned, during my prepared remarks, going forward, we are going to continue on the assets light operation efficient business model. In the meantime, we keep close eyes on the M&A opportunities to expand our product platform and also the enrichment of contents. But however, at this moment, we don’t have targeted – focus a target yet. But when we do, when the opportunity do come, we will have no hesitation to invest. But once again, at this moment, we don’t have focus target on the upper stream, downstream businesses. And also, for the telemarketing-related expenditures, we are going to continue to invest in the branding empowerment. That is a long-term initiative for the Company, for us to grow our user base, in the longer run. And then for short run, as Tanzo just mentioned, when the right time comes, we will intensify the investment in marketing channels for new user acquisition. But however, we do monitor the cost and benefits, and then spend the money carefully. Secondly, we are going to continue to invest on our human capital. We do believe it is the future of the Company. So that is our key investment area we are going to focus on. But however, as a public Company, we do balance the investment and the financial metrics we promise to the market. So from time to time, the market may fluctuate, but if we invest, that is going to be for the long-term well-being.

Thank you very much, Tanzo and Jonathan.

Yes. Thank you, Alex.

Okay. We’re ready to conclude this call this time, Operator please.

Thank you. Ladies and gentlemen, that does conclude your conference for today. Thank you for participating and you may all disconnect.