Hello Group Inc. (MOMO) Q2 2017 Earnings Report, Transcript and Summary

Welcome to the Second Quarter 2017 Momo Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] Please note this conference is being recorded today. I would now like to hand the conference over to your first speaker today Ms. Cathy Peng. Thank you. Please go ahead ma’am.

Thank you operator. Hello everyone and thank for joining us today for Momo’s second quarter 2017 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. Wang Li, Co-President and Chief Operating Officer; and Mr. Jonathan Zhang, Chief Financial Officer. Mr. Tang and Mr. Wang will discuss Momo’s business operations and company highlights followed by Mr. Jon 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 to Mr. Tang. I will translate for him. Mr. Tang, please.

[Foreign Language] Good morning and good evening everyone. Thanks for joining our conference call today. We have another good quarter with solid financial performance, as well as progresses and achievements in user expansion, product innovations and business development. [Foreign Language] Total revenues keep hitting new record highs at $312.2 million, up 215% year-on-year. Adjusted net income for the quarter reached $73.6 million, up 217 from the same period last year. [Foreign Language] Now a deep dive into the quarter. Firstly, on user works. Total MAUs on Momo platform reached 91.3 million for the quarter, up 22% year-over-year and representing over 6.1 million net additions on the previous quarter. As the user growth continues to accelerate, average content per DAU in the second quarter remained stable bought on a year-over-year basis and on a sequential basis. [Foreign Language] Our reporting and MAU only includes those users who access our service through the main Momo platform. Those users who access our content and services to properties owned and operated by third parties are not calculated as our active users. In the month of June, the users who access our services and content from third party properties where somewhere around $20 million in total. Although we are seeing third-party traffic going rapidly as we continue to expand our content offering in short video and live streaming areas, at the current stage we are not including them in our MAU calculation because of the limited amount of information that we have on those users and the fact that we have no intention to manifest the third-party traffic in the near-term. Active users on our stand-alone application such as Hani and jointly operated games are not included in our reported reporting MAUs either. [Foreign Language] Now let me walk you through the key initiatives that we took in the second quarter to drive the user growth. [Foreign Language] Firstly, on the marketing efforts, as many of you know in mid-April, we launched a nationwide branding campaign to drive the marquee awareness of our used case expansion and to list a brand image of the Momo platform. In June, we worked with a third-party agency to evaluate the effectiveness of the Q2 campaign regarding those objectives. According to the survey results, the campaign has met our expectations in terms of coverage and reach and it also contributed positively to the improvement in brand initiative. However, we do have further room to refine the key messages in our campaign. As we move into Q3, we are adjusting our marketing strategies accordingly to improve the long-term effectiveness of our branding efforts. At the same time, we plan to lean more towards direct-pay channel marketing efforts in terms of the budget allocation in order to optimize the return on investment of our marketing initiatives. [Foreign Language] On the direct user acquisition front, in Q2 we pushed harder on the pay-channel and user callback side to drive new downloads and resurrect the users. At the same time, we continue to optimize the registration process in order to bring down the barriers in our on boarding experience. Historically, paid user acquisition and conversion were not one of our key areas of focus. As we start to be beef up our efforts on those fronts we are bringing in a professional team to manage the user growth process with greater granularity. The goal here is to make sure that our channel marketing efforts meet our standards in both quality and profitability terms. We do believe that we have plenty of opportunities to drive continuous strengths at the top of the user funnel and improvement in retention within the funnel. [Foreign Language] As I said many times before, the alternate underlying driver for user growth is product innovation. In the second quarter, we saw pretty strong growth in organic new registrations that are not from paid marketing channel. That can be attributed to the continuous expansion of our entertaining content ecosystem. Now let me give you a brief overview of the progresses we made on the product development and operation front. [Foreign Language] One of the key areas of focus in Q2 was constant operation revolved around short video. We are making remarkable progress on optimizing the algorithm as our recommendation engine to more effectively disseminate the UGC content on our platform, which is increasingly video centric. The improving content distribution efficiency is driving impressive growth in short video activities. During the second week of August, our users created and shared 3.5 million posts on daily basis and a considerable portion are already in video format. Over that period of time, the average number of daily original video published grew 49% from 3 months ago. Daily video viewed increased by 57% and the number of interactions with short videos were up 60%. The effective users of our short video service has already covered around 58% of our total active users. We’re happy to see that more and more people are adopting video as a way to more effectively express themselves and also to better get to know and interact with each other. The core of our short video efforts is helping the users make connections more effectively through content creation and consumption. We will continue to steer our short video and other content initiatives towards that direction. [Foreign Language] In addition to the remarkable progress we have made around for video service, on July 12 we launched a major new version Momo 8.0. In this version, we adopted a pioneering modular design for the home page featuring all the major existing social and entertainment offerings on the platform, as well as newly piloted product initiative. [Foreign Language] I said in our last earnings call that in the coming couple of years there are two secular trends that we need to write on. Number one is that video increasingly becomes the primary way that younger generations share and interact with each other. Number two is that off-line recreational activities are moving online, while we are seeing big opportunities here, a lot of the transitions in those territories are still in their early days. Therefore we need to continue to innovate and test new things out. One of the key objectives we are trying to achieve through the 8.0 update is to build a foundational structure to scale our of future product experiments without interfering on the existing social and content experiences. Under the new structure our team will be able to pilot new services with the support of sizable traffic from the homepage so that we can quickly experiment on new projects and reiterate on the experiences in a much more efficient manner. During the past six years Momo's growth has been powered by constant product innovations and use case expansion. What we learned from that evolution process is that when it comes to how young people socialize and have fun their demand and preferences are so diversified that it’s hard to find a one size fit all kind of solution to engage everybody. The modular design allows us to support multiple social experiences without having an overly complex catalogue system and navigation process. At the same time, it also opens up more diversified development path for our future. [Foreign Language] Version 8.0 also bought to the users a few new life interaction experiences, including [indiscernible] Werewolf, which is a social game and two live video chat experiences [indiscernible]. With these new social and entertainment experiences we are going deeper with the strategy to connect social activity with recreations and entertainment. In addition, we are made to apply the life streaming technology to a broader set of use cases than the traditional virtual showroom experience with the past performers. We believe live video and streaming technology can make the interactive experience in-between ordinary users more compelling and immersive as well. We will continue to reiterate on the experiences and make further explorations on that front. [Foreign Language] Today the various social and content experiences on Momo, Momo, including Nearby People List, the NDN [ph], live video and short video services, the show social games and the groups are forming a dynamic community for our users to build social activities around. All of these different offerings serve the same core user demand that we've always been wanting to serve to discover and connect with interesting people around and interact with them in a timely and effective manner. [Foreign Language] Overall, we are happy with the new version based on the analytics that we have seen and the consumer feedback we will quickly allow new iteration to optimize the existing offerings and continue to bring new experiences to our users. With that, I’m passing the call over to Mr. Wang Li, our Co-President and COO for business review. Mr. Wang please.

[Foreign Language] Now let me walk you through the key things that we’ve done, as well as the future direction for our major business lines. [Foreign Language] Firstly, on the live streaming business, in Q2 we continue to optimize our tournament experience. In June, we won the second season of our 2017 live streaming tournament and introduced a new gamification called Liang Shun [ph] to make the knockout matches more compelling as the content experience. At the same time, the tournament also outperformed our relational expectation in driving the shipping revenues. Through continuous upgrades of the tournament system and introduction of new gamifications we’re building the tournament into an indicative content and community experience that provide ongoing motivation for the performers and the viewers. [Foreign Language] Other than the quarterly tournament, we also took a few other initiatives to drive the content upgrades. For example, in the second quarter we teamed up with four prestigious record companies to roll out a music production project called Momo Golden Song. The program involves an open audition and contract system to showcase singing talent from the platform. We have been working with BMG and Tycho Music to publish songs for the top winners in the first season of the Golden Song contest. In August, we started to debut the professionally produced songs through the top online music platforms in China. With that effort we’re hoping our top singing talents to extend their career path from live streaming to the broader entertainment industry, which in turn would help us attract more broadcasters with real performing talents to improve the content quality on the platform. [Foreign Language] During the second quarter, based on the multiple connected channel technology, we launched the dating live channel within the live streaming service, both operational and financial indicators of the dating business has been satisfactory. We are in the process of recruiting channel moderators to expand from dating to other types of gamification towards each channel. We will continue to experiment on new ways to utilize live streaming technology and push the used case beyond the traditional virtual showroom model. [Foreign Language] Now turning to mobile marketing business, in our last earnings call we said that the team will start to defocus on some of the app formats that have low compatibility with the core attributes of the platform and develop more efforts into exploring the type of ads that work more natively with the video and entertaining content environment. With the 8 series launch that trend is accelerating. Traffic and engagements are moving from auto used cases such as Nearby People to newer ones such as the NDN [ph] [00:24:57] short video and live video. Eventually, we would like to see the same trend in app placement as well. Although we won't be aggressively pursuing revenue growth for the marketing business in the near-term over a mid- to longer time horizon we do see plenty of opportunities to drive the growth of this business. We’ve been testing a couple of ad units in the three major product modules in the new version. Even at the testing phase where the bidding is only open to a limited number of customers, the effective CPM is already meaningfully higher than the average level we saw in the past Q2. That shows that the newer content environment and the product environment leave more room for native ad creators is also going to be more effective. As we continue - as we keep building up the engagements and traffic around the video and entertainment content experiences, the marketing canvas is becoming richer to the marketers. We will continue to explore and innovate on the ad format to figure out the best way to conduct effective marketing in the new environment. [Foreign Language] Now firstly on game and app. For the game business, in the near-term the bigger the focus is on growing the user base and engagement of Werewolf. Our goal for the game is to build it into a social and entertainment experience with a sizeable user base, facilitating the effective interactions in between the Momo users. [Foreign Language] Vast business continues to do well driven by the virtual gifting service. We’ve already brought virtual gifting service into some of the newly introduced experience such as Quick Chat and Werewolf. We intend to continue to test new use cases to further drive the monetization and the improvement in the interactive experience around it. As we keep extending the use cases for our virtual gifting service, we expect our vast business to continue itself the growth trend in the future. [Foreign Language] Overall, Q2 was a busy quarter for us. Many big plans have been carried out and more hard work is ahead of us. We will continue to execute and deliver according to the laid out roadmap. With that, I’m handing over to Jon for a financial review. Mr. Jon please.

Thanks Tang Zong and Cathy. Hi everyone. Thanks for joining our conference call today. We are very pleased to deliver another strong quarter with a total revenues growth of 415% year- over-year reaching $312.2 million, compared to $99 million in the second quarter 2016. The total revenues for the quarter exceeded the top range as we guided during the previous quarter earnings announcement. Although we significantly stepped up our investment in branding campaigns in the second quarter, I’m glad to see that with a robust top line growth coped with a strong operating leverage of our business model. We were able to deliver a 28% non-GAAP operating margin up from 22% the same period last year. Non-GAAP net income for the quarter was $73.6 million, up 217% from the same period last year. Now looking to the key revenue line items. In the second quarter of 2017, revenues from live video services continued to generate strong momentum with total revenues reaching $259.4 million, up 348% year-over-year. The year-over-year growth in live streaming revenues was largely contributed by the 206% increase in the quarterly paying users, which totaled $4.1 million for the second quarter 2017 versus $1.3 million for the same quarter last year; and to a lesser extent the 54% increase in average revenues for paying users per quarter, before excluding value-added tax or quarterly ARPU, which was 463 RMB in the for the second quarter of 2017, compared to 301 R&B for the second quarter 2016. Effective DAU penetration rate for the live streaming services was approximately 24% in the second quarter of 2017, up from 13% for the same period last year. In addition to the overall business space expansion, I’d like to reiterate that the higher than expected revenues from live streaming service were attributable to our continuous efforts in further improvement of our tournament system and development of new gamification to enhance experiences and evolvements for the broadcasters and viewers as Wang mentioned earlier. Revenue from mobile marketing was $19 million, up from $16.6 million for the second quarter of 2016. The 15% year-over-year growth was mainly driven by better sell-throughs of our ad inventories. Although the big majority of mobile marketing revenue for the second quarter this year still came from small and medium-size businesses. The revenues from brand marketers and a number of key account customers grew significantly year-over-year and sequentially. However, as a percentage of total mobile marketing revenues it’s still at ramping phase. We do anticipate and will become more significant in the coming few quarters. Now I would like to briefly comment on how the version 8.0 upgrade would impact the mobile marketing revenue in the near-term and more specifically the third quarter. On July 12, we launched version 8.0. In the new version, usage and traffic where moved away from nearby people function. The previous default lending page to work newer use cases that are more video and entertainment centric. We also removed all of the three ad inventories that were previously in the frame of nearby posts. We expect these changes to negatively impact mobile marketing revenues in the third quarter. On the other hand, as we have currently seen increasing demand for video marketing solutions we started testing a few new formatted ad units in three major product modules in the new version, namely nearby posts the NDN [ph] and recommended for videos. The ECPM we have seen so far into Q3 is higher than the average level that we saw in Q2 which could partially offset the significant decrease in the total ad inventory made available to new version. Given we are carefully limiting the ad low in order to protect user experiences in the short-term, we are very optimistic about plenty of opportunities to drive the longer-term growth of mobile marketing business on our platform as long as we continue to build up traffic in engagements within our content ecosystem. Now quickly on vast and gaming services. Revenue from vast, which currently includes membership subscriptions and virtual gifting service. Together it was $24.6 million, an increase of 58% from the same period last year. Virtual gifting service was the main driver for the growth in this line item during second quarter. The loan membership subscription revenues also contributed to the year-over-year growth. Since the virtual gifting revenue has become a very significant portion of revenue, starting from this quarter onwards, we will discourse disclose the paying users for the vast business to include the paying members as of the last day of the quarter and paying users for any non-live streaming related virtual gifting service without double counting the overlap of the two cohorts. For the second quarter of 2017, total vast paying users were $4.5 million, up from $3.2 million for the same quarter last year. Mobile games revenue was $9.1 million, a 3% [ph] increase from the same period last year. The year-over-year increase in mobile game revenue was once again primarily due to the revenue contribution from Momo Dance Battle version #, which was recognized on the gross basis. However from a substantial perspective, our strategy to be focused on jointly operated games could continue to pressure the game revenue in the near term before any of our self developed games latest version in monetization. Now a brief review on the cost and expenses items. Consistent with the previous quarter, the two biggest cost drivers for the second quarter of 2017 were still the revenue sharing we provide broadcasters and payment channel fees. Growth rates of this cost component are linear to the live streaming revenue growth, while we continue to enjoy significant scale efficiencies in our other cost items both year-on-year. Non-cash sales and marketing expenses for the quarter was $66.1 million, compared to $24.8 million for the same quarter last year representing 21.2% and 25.1% of revenues respectively. The increase in marketing spending contributed significantly from the nationwide branding, campaign that we launched in the second quarter of this year, and to a lesser extent stepped-up efforts on paid marketing channels, sponsorships to Internet, dramas, variety shows, promotional events, on live streaming, and short video services. Our Q2 branding campaign covered a nationwide movie theatre network, public transportation hubs, office and residential buildings, and various other outdoor media outlets, as well as online media platforms such as [indiscernible] and achieved an expected reach of our targeted user base. For the third quarter, we plan to continue to invest in the branding efforts, in the movie theatre network, sponsorships to Internet drama, as well as the online media platforms. Promotional efforts on live streaming and short video services will continue as our ongoing part of our operation. Overall, we expect the total marketing budget to remain at similar level in terms of smooth indiscernible dollar compared to the second quarter. However, we intend to allocate relatively more budget toward direct user acquisition efforts and to maintain some level of flexibility on an as we go basis in order to optimize the results of our overall marketing investments. Our non-GAAP R&D and G&A expenses for the second quarter of 2017 were $8.2 million and $8.5 million, representing 2.6% and 2.7% of total net revenue respectively, compared to $6.1 million and $4.6 million or 6.1% and 4.6% respectively for the same quarter 2016. That demonstrated our highly scaled efficient business model allow us more room to strengthen our talent pool. We ended the quarter with 1,072 total employees, up from 805 a year ago. Vast majority of the increased headcount are in the technology, product, and service development areas. In the second quarter 2017, one of our operating entity received a $7.2 million incentive from a local government. Such incentive is based on a total taxes paid locally, including value-added tax, corporate and individual income taxes. As there are significant uncertainties on timing and amount we receive such incentives, we only recognized the amount we received as other operating income upon receipt. Now turning to our third quarter 2017 guidance, we estimated the third quarter revenues to come in the range from $337 million to $342 million, which translates into a year-on-year growth rate from 115% to 118%. This guidance range is based on continuous strong growth in live video service we currently observe and a meaningful decline in revenue from marketing services and mobile game business from the Q2 level, as I described earlier. Please be mindful that forecast represents the company's current and preliminary review on the market and operational conditions, which are subject to change. That concluded the prepared of prepared portion of our today's discussion. With that, I’d like to turn the call over to Cathy to start the Q&A session. Cathy please.

Just a quick reminder, for the Chinese speakers please ask the question in Chinese first followed by English translation and also please limit the number of questions asked, so we could take in more people. Operator, we are ready. Please start to connect people in.

Thank you, ma’am. [Operator Instructions] We have the first question from the line of Binnie Wong. Please ask your question.

Good evening management. Thank you so much for taking my question. So, I have two questions here. One is that we see the growth with the number of paid user this quarter has been quite flattish; conversion rate has also been coming down, what is the reason behind that? In relation to that, we understand the latest 8.0 version offers more social networking tools, be online forecasting, say, short video, Quick Chat and NDN, isn't that monetization potential is currently quite limited on this new function. Why would more Momo divert its traffic away from live broadcasting, a very good monetization tool? That’s my first question. My second question is, in terms of the margin trend, I understand we’re investing more as marketing expenses to drive faster growth, how effective have you seen in terms of like say any metrics you can share, say a percentage of new user recruit or any user cohort will be helpful, and how should we expect this to normalize, would you expect that some of this marketing and branding investment remark, so like one of maybe in second or third quarter, when should we expect to normalize going forward? Thank you.

Binnie, yes, if you could do that it would be great.

[Foreign Language]

[Foreign Language] Okay. I will try to capture everything. So the question is on the fattish trend in the live streaming paying users in this quarter. I think that can be attributed to the fact that some of the users have shifted part of their activities from the long tail smaller live streaming chat rooms towards newer used cases, I mean the audio and video-based life interaction experiences such as Quick Chat and Werewolf because essentially they kind of fit newer used cases kind of satisfied exactly the same kind of user demand. I will give you an example here. For the Quick Chat experience on daily basis we had somewhere around 50,000 daily paying users sending wrap packet. On a monthly basis, we had 800,000 these type of paying users sending wrap packer, however because the wrap packets are recorded as the company's revenues because they were not taking revenue shares from the wrap packets and on the top line, so the revenues going to wrap packet are actually not recorded as the company's revenues, and thus the users that - the users sending wrap packet are not reported as our paying users either. However, we are seeing for the Quick Chat kind of new social experiences, the paying users who paid to send wrap packet have been increasing pretty rapidly. Your second point is, why we would divert traffic from our very monetizable live streaming service to more newer used cases. I think the key thing here is that we’ve never been positioning Momo as a live streaming company. We have always been positioning Momo as a social company and we’re seeing these - the user experience, the social experience around the newer used cases are actually pretty good in some ways actually better than the live streaming service. So although the newer used cases currently do not monetize at the same level as the live streaming - traditional live streaming service does, we will like to make more explorations on those front to drive the overall user experience around the social activities. We think that kind of transition is very healthy for the platform. For Momo as a social platform in the long term. So that’s for your first question.

[Foreign Language] Right, maybe one quick point to add. Right now we are seeing very - we are seeing the use cases such as Quick Chat and Werewolf already reaching a pretty good level in terms of the user base within the application, as well as the per user time spend around these newer use cases. So we do believe that in the long term we should have plenty of room to drive demonetization around these new product experiences. However in the short-term I don't think demonetization is the focus here. I think the focus is still around building up the activities and usage around them.

[Foreign Language] I think on the one hand it’s a little bit difficult to measure the retail investment in the short-term for branding activities. On the other hand, we did see a pretty decent growth in the organic new registrations in the second quarter that are not coming from pay-channels. I think that has something to do with the branding efforts. The other thing about the future trend, I think in Q3, the overall marketing budget is still going to remain at a pretty high level, but in terms of the - in terms of how much we will end-up spending and in terms of the budget allocation in between the branding activities and direct user acquisition efforts we’re going to maintain some level of flexibility in order to make adjustments on an as we go basis. And I think overall, we are going to - in terms of budget allocation try to lean more towards direct user acquisition efforts as opposed to branding efforts.

[Foreign Language]

Operator, we're ready for next.

Thank you, ma’am. We have the next question from the line of Zoe Zhao from Credit Suisse. Please ask your question.

[Foreign Language] The first question is regarding our team members. We saw the team members up a lot this quarter, how much of that is related to your features of the version 8.0 and how much of that is membership subscription? And the second question is, when shall we expect an acceleration in other pricing revenue? Thanks.

Hi Zoe, this is Jonathan. Let me address your two questions. Firstly, as I mentioned during the prepared remarks, starting from this quarter on, since we have seen the virtual gifting paying users has become a significant - virtual gifting revenue has become a very significant portion of vast revenue, so we started from this quarter, we disclosed the paying users for the vast services on a blended pattern. So the of 4.5 million paying users for vast services for second quarter 2017 actually includes both membership subscribers and paying users for virtual gifting. We do not separately disclose further breakdowns from this point onward. And for the $3.2 million paying members during the second quarter 2016 because that was purely for the membership subscriptions because we launched virtual gifting services in Q4 2017. So, I hope that answers your first question. Second one is, as I’d stressed during the prepared remarks because of the product changes we predict the marketing revenue will decline on a sequential basis in Q3 and as Wang Li mentioned we are testing out new set of advertising inventories to be launched in full scale gradually over time. So we anticipate the marketing revenue will start on the upward trend in Q4, so Q3 probably will be the lowest.

Great thanks a lot. That was very helpful.

Okay thank you.

Operator, we're ready for the next.

Thank you, ma’am. We have the next question from the line of Tian Hou from TH Capital. Please ask your question.

[Foreign Language] As the company is more focusing on short video content, the two things I would like to know, Wang, how do you attack each content, what is the hiding logic? The other issue is about the content recommendation, how do you optimize the recommendation algorithms, so that’s the two question? Thank you.

[Foreign Language] Okay. So one of the key things that we did in the second quarter in order to improve the algorithm of our recommendation engine is that we've built a system that allows us to evaluate on a real-time basis the content quality for the vast amount of user generated content distributed on our platform. At the same time, we built a hierarchical kind of content distribution mechanism that help us surface the quality user generated content from the bottom all the way through to the top according to their respective quality grades. And the only here is still make sure that the higher the content quality is the greater level of user exposure that piece of content can get on the platform. And through such a kind of content distribution mechanism we very significantly improve the efficiency in content distribution and increase the user exposure of the quality, user generated content, and raise the overall content quality and the engagement level around our short video activities. Regarding the question about personalized recommendation logic and content tagging logic, I think our system is pretty much based on what is called collaborative filtering. This is a rather complicated and sophisticated mechanism. To put it simple, the system will assign different interest tax to users according to their respective interest graph and then what you are going to see - what you are more likely going to see on the platform is largely determined by the type of content that other users with similar interest tied to you gravitate toward, and that gravitation is further defined by user actions such as clicking through liking or other type of engagement. I hope that answer your question.

So that concludes our call today. Thank you for joining our conference call. We will see you next quarter. Operator, we're ready to close.