Tencent Music Entertainment Group (NYSE:TME) Q2 2023 Earnings Call Transcript August 15, 2023

Tencent Music Entertainment Group beats earnings expectations. Reported EPS is $0.97, expectations were $0.14.

Tony Yip: Good evening and good morning. Welcome to Tencent Music Entertainment Group’s Second Quarter 2023 Earnings Webinar. TME announced its quarterly financial results today before the U.S. market opens and earnings release is now available on our IR website at ir.tencentmusic.com as well as via Newswire services. Today, you’ll hear from Mr. Kar Shun Pang, our Executive Chairman, who will start the call with an overview of our recent updates. Next, Mr. Ross Liang, our CEO; and I Tony Yip, as CSO, will offer additional thoughts on our product strategies, operations and business developments. Finally, with Shirley Hu, our CFO, we will address our financial results before we open the call for questions. Before we continue, I refer you to our safe harbor statements in our earnings press release which applies to this call as we will make forward-looking statements.

Please also note that the Company will discuss non-IFRS measures today, which are more thoroughly explained and reconciled to the most comparable measures reported under IFRS in the Company’s earnings release and filings with the SEC. At this time, all participants are muted. After management’s presentation, there will be a Q&A session. And please be advised that today’s webinar is being recorded. With that, I’m pleased to turn the call over to Kar Shun, Executive Chairman of TME. Kar Shun?

Kar Shun Pang: Thanks, Tony. Hello, everyone, and thank you for joining our call today. We’re pleased to report a solid second quarter with total revenues increasing by 6% and adjusted net profit of 48% year-over-year. These solid results were once again supported by our online music services, strong momentum. 10 years, TME has been dedicated to driving the health in development of China’s online music industry following our long-standing efforts, we are pleased to see users becoming increasingly accustomed and we’re willing to pay for copyright music. Whether for songs, they want to listen to or for the premium listening features, they enjoy. Right on this way, we are happy to see that our online leasing paying ratio and monthly ARPPU reached an all-time line of 16.7% and RMB9.7 respectively.

Such achievements drove revenues from this business player in the recorded quarter to exceed that of social entertainment services for the first time in our history. This is a strong testament to our progress in developing a robust online leasing business model and marks a significant step along TME’s growth plan. Looking at our social entertainment services, starting from the later part of the second quarter, we have proactively implemented several service intension and risk control measures to provide users with a more music-centric large fearing hemisphere as well as reinforce with controls. One of these measures are expected to put pressure on revenues from our social entertainment services throughout the second half of 2023 and first adversely impact our total revenue for this year.

We believe they will provide users with an optimized user experience as well as pave the way for the group healthier and more resilient development in the long. Moving on to our operational progress on content, as the key components bolstering our music ecosystem, our comprehensive content ecosystem sets us apart from other industry players. During the quarter, we continued boosting the vibrancy of our content ecosystem among artists, creators and labels. On the front of top-tier labels and artists, we strengthened our partnership with them to expand our industry influence and content appeal. In July, we held the Tencent Music Entertainment Awards 2023, also known as TMEA in Macau. It was a two day event compressing of two music ceremonies and two music festivals joined by a prominent nightclub of over 80 well-known domestic and overseas musical groups and singers such as [indiscernible] being able to successfully organize such a large-scale offline performance of four music events over a single weekend coupled with an exceptional launches of musicians demonstrating our strong industry influence and organizational capabilities with an audience of nearly 40,000 people offline participating in our two day event.

Our TMEA also inspired the social media versus over 10 billion views, once again, creating a national music sensation. Furthermore, we remain the partner of choice for famous labels and artists on a wide range of content offerings and merchandise. This enable us to provide music levels for rich selections of music content, and products, as well as a unique and trendy experience at TMEA. For example, in the second quarter of 2023, we renewed our strategic cooperation with forward music, allowing us to offer a wider variety of Chinese pop music to users in China and abroad. In addition, we cooperated with Jackson Yee on the release of his new physical album, Liu Yanfen. Featuring a head-start release with TME, this partnership delivered an outstanding sales record of Liu Yanfeng our platform.

Another, highlights was the debut of Chris Lee’s Liu Xing brand new digital album have rating so more required, plus the sales of the her album’s limited edition merchandise. In addition, we continue expanding our vertical music content to attract a more younger audience. For example, milestone records our team hiphop labels joined our platform, adding over 440 songs to our hiphop music library, some of which include 30-day head start releases. On the front of up and coming musicians, we are helping the artists rise in visibility within the industry by providing critical technological assistance and integrated resources that support their global followed music journey. In July, we upgraded Venus, our all-in one music production and promotion destination to better help Indian musicians improve their efficiencies in producing transacting and promoting songs, Gen latest iteration and integrated our full suite of AITC in Venus, as AI-enabled music separation, set music generation, online rating and creations of couple songs, significantly improving creators efficiencies actually step up the music creation process and elevating their music quality.

Venus also creating enhanced the efficiencies of resources consolidation as we gave us a wealth of demos on its platform and powers convenience music transaction and promotion processes. Having attracted a diverse range of creators and labels, Venus has record music transactions with a total value of over RMB10 million as of the second quarter. Furthermore, we’ve leveraged our differentiated and comprehensive set of resources and opportunities to further up and coming musicians and foster creativities For example, our Tencent musician platform strengthen its holistic support system for musicians, which ranges from offering additional exposure for offline performances, to launching theme programs to promote creative content production, and even extends to helping musicians fund commercial opportunities.

In the second quarter, our emerging force program sends several of its emerging artists to seven offline music events. We also offer them more field and in the event the opportunity to produce the film songs for Beyond This Card, Sales Celebration events. Our deep involvement across the music value chain and enables to be in the unique position of having extensive insights in China’s music industry, which we in turn hope to give back to the industry by contributing to its advancement. In June this year, our TME Research Institute released its first consecutive annual edition of 2022 year-end report of digital music in China. Through in-depth data analysis and multi-faceted interpretation, we provide a comprehensive and pioneering insights as well as case studies aiming to promote healthier and more sustainable industry.

That concludes the overview of our second quarter our second quarter and the progress we have made across our growing content capabilities. I would now like to turn the call over to Ross. He will share more about our platform strategies. Ross, please go ahead.

Ross Liang: Thank you, Kar Shun. Hello, everyone. We are excited to have reached an important milestone of 100 million online music paying users in June. This demonstrates our strength as Chinese leading online music platform and reflects our growing appear to music lovers. As we see an increase in growth potential materializing from users moving music consumption mindset. We are continually elevating our music experience to meet users’ high standards and a stronger desire for quality. On top of the progress, in our content ecosystem, as Kar Shun shared earlier, we are continuing to optimize user experience on our platform in order to reinforce the attraction of our lively and passionate music community among music lovers, along with the ongoing refinements to our distinctive and immersive listing experience, we are also exploring more innovative and personalized means of entertainment and interaction.

In terms of user experience, we optimized premium feature and the product experience to attract per user engagement and stickiness to our platform. For example, QQ Music upgraded its series of QQ Music audio jumping in [indiscernible] to ensure optimal sound quality and effects, which are now also available in our in-car service. We also launched QQ Music audio certification, with high industry standards for sound quality across hardware devices such as earphones speakers music players and the car audio figures, allowing access to superior sound quality among users in their daily life. QQ Music also expanded in the 3D music player offerings such as players customized for some scraps or designed for classical music to bolster product attractiveness and thus user use.

QQ music flagship X is recent upgrade, we highlighted a more intuitive interface and an engaging unlimited music discovery function. We have also unveiled its Viper 3D [indiscernible] changing ton, bringing an immersive live concert like leasing experience to users. Furthermore, music introduced a brand new function in doing that enhance users’ recording and the same experience, including optimized work the details enhanced the balance between human voice and accompaniment and wider selection of sound effects as well as recording skins. Coupled with these enhancements, we also strengthened our ability to recommend the music through refinement user preference and analysis and optimized algorithms allowing covenants and individualized milk discovery.

All of these efforts contributed to high BOs derived from various recommendation scenarios and a larger portion of the recommendation-related streaming share. In terms of leasing scenarios, we expanded our music services to additional use cases, such as various IoT scenarios to serve a large audience in a more immersive way. Specifically for the in car usage, we improved user experience across on quality and events, music recommendation and interactive functions. For example, QQ Music launched its in car washing two in June this year and forge partnerships with more car makers such as SAIC, Volkswagen, FAW, Volkswagen and more, among others. We also expanded cooperations with more car makers and embedded our in-car offerings in more car models, potentially typing into a wider base of users who then can enjoy a seamless native in-car music listening experience.

Alongside the recovery of off-line orders, driving time high lines, thus increasing the use of in-car music services. As a case important, during the Labor Day holiday period on the summer vacations, we saw a notable uptick in user activities and stickiness for our in-car service. In terms of user engagement and interaction, we created a highly individualized and [indiscernible] music entertainment experience for users through our AITC in diverse. We are fulfilling their desires for trending filters to keep up with the AITC import. On the online music side, we started to test AI-enabled listening together that [indiscernible] our AI music company to join users’ music listening journey share a variety of topics include clear wells on music and recommend songs or playlist based on their real-time interaction.

This new function will offer users an interactive fun way of discovering music as well as a more personalized and engaging music leasing experience. On the live streaming side, we innovated AITC import virtual gifts to facilitate more trend citing interaction between users and anchors. Such virtual gifts can be automatically more virtualized quickly as users import text descriptions, promoting a more creative and unique user performer bonding during live streaming. All these efforts are in turn reinforced our platform traction among users. As we continue exploring opportunities and possibilities in China’s online music arena, our dedication to copyrighted music will position us to better ride the wave of users changing music construction hybrids, promoting great possibility across the music industry, we are creating long-term value for our shareholders.

With that, I’d like to give the floor to Tony to review our business options. Tony, please go ahead.

Tony Yip: Thank you, Ross. Hello, everyone. For online music services, our efforts over the years to cultivate users’ copyright awareness are bearing fruit, paralleling U.S. users increased willingness to pay for premium music content and optimal listening experience, we continue to see exciting growth in online music subscriptions. The number of paying users reached a record high of 99.4 million in the second quarter driven by a combination of operational measures such as refined operation strategies, which explore opportunities associated with transit topics of special occasions, more subscriber privileges and additional attractive music content. These factors translated into new paying users returned churned subscribers and improved user retention.

In addition, we launched a premium package tailored to couples in June, promoting customized features and privileges between couples. In terms of paying user spending, we witnessed a monthly ARPPU increase for the fifth consecutive quarter to reach an all-time high at RMB9.7 in the second quarter. The ongoing uptick was mainly a result of effective promotional activities, a consistently high user retention rate and the increased appeal of our subscriber privileges, among others In addition, we made notable progress in our in-car music services as well, seeing expanded user base and enhanced monetization primarily as a result of extensive relationships with more carmakers and its applications in more car models. Online music services other than subscriptions also delivered robust growth as we further enhance monetization.

For advertising, our diversified product portfolio and innovative ad format remain highly attractive to advertisers across different industry verticals. Advertisers from e-commerce new gaming and travel industries were outperforming on the advertising spend list. Ad-supported mode continued outperforming our overall advertising services with penetration steadily improving and revenues significantly increasing. Sponsorship advertising also attracted various types of brand advertisers as our IP mix provided them with a broad and diverse target audience, such as our campus music contest Nexinga2023, our signature music event, Wavemaker, QQ Music, Danone Music Festival and Coal music festivals with barbecue-related themes. Such a portfolio of music IPs attracted Sprite, Toning [indiscernible] JD.com to sponsor, among others.

As for artist merchandise, we also saw an exciting performance driven by our strong relationships with well-known artists, which normally gives us a head start in the release of the albums and sales of various merchandise. Moving to social entertainment services. As Kar Shun mentioned, starting from the latter part of the second quarter of 2023, we have implemented several service enhancements and risk control measures across our live streaming services to provide users with more music-centric user engagement experience, such as adjusting certain live streaming functions and adopting more stringent compliant procedures. Such measures led to a weaker-than-expected performance in our social entertainment services for the reported quarter and will bring continued adverse effects on its revenues throughout the rest of this year.

As a result, we expect our total revenues for the Company to experience a low to mid-teens percent decrease year-over-year for the third quarter of 2023 and a low to mid-single-digit percent decrease for the full year 2023 as compared with 2022. Nonetheless, we remain confident that we will deliver year-over-year bottom line growth for 2023, driven by the continued strong performance of online music services. We also believe all these efforts will lay a more solid foundation for TME’s sustainable and resilient development in the long run. Meanwhile, we are also trying out new interactive features such as AIGC-empowered virtual gifts and functions of bullet chats in our live streaming services to enhance user interaction experience while increasing our product competitiveness.

In addition, we continue to explore overseas opportunities, leveraging our operational experience in the domestic market. For example, we further enhanced user experience in overseas singing rooms and introduce new localized features to boost engagement showing satisfactory initial results in both penetration rate and tone. Last but not least, TME continue to fulfill its social responsibilities in a unique and distinctive way through its strong commitment to music-based social welfare activities. In the second quarter, we cooperated with Tencent Charity and other public welfare organizations and help two Little Red Flower Charity Concert [indiscernible] play for children. In May, we hosted the first concept to raise public support for children with hearing impairment.

We helped seven hearing impaired children replicate their own voices with our lining AI capabilities then utilize their AI-generated voices to create and perform a concept along with several musicians. On Children’s Day in June, we hosted another concept for children in rural areas, offering them a platform to express themselves through music while showcasing music esthetic education in those villages. These programs not only raise the public emotional resonance, they also allow us to explore music possibilities and across an impact across different areas. Going forward, we will continue to drive progress across our content and platform to bring users a differentiated superior music entertainment experience that can only be obtained on TME’s platform while sharing the fruits of industry development with all other stakeholders across the music value chain.

I am so proud of the progress we have made both as a company and as an architect of the online music industry’s future. Thank you once again for allowing me to be a part of this incredible journey. Now, I would like to turn the call over to Shirley, our CFO, for a closer look at our financials.

Shirley Hu: Thank you, Tony. Hello everyone. Next, I’ll discuss our results from a financial perspective. In the second quarter of 2023, driven by significant growth in our music subscribers and the advertising business, our total revenues reached on the quarter leading up by 6% year-over-year. Revenues from online line services contributed 58% of total revenues, passing the revenue contribution from social and challenged service for the first time in our history and marking a significant milestone for us. IFRS and non-IFRS profit was RMB1.3 billion and RMB1.6 billion, respectively. Net operating net profit margin reached 21.7% this quarter. Music subscription revenues in Q2 reached RMB2.9 billion, up by 37% year-over-year. And like 11% expenses with rapid expansion of online managing new sales and the continued increase in monthly ARPPU.

Specifically longer of online means paying user grew to 99.4 million up by 20% year over year, representing net of 5 million users sequentially. Monthly ARPPU has grown for five consecutive quarters and reached a record high of RMB9.7 this quarter, up by 14% year over year and 5% sequentially. Our will optimize the use of operations, more appealing member privileges, attractive music contents, and the discipline the promotions have driven the growth and will continue to suggest the foundation for sustainable growth in our music subscription business. Additionally, revenues from advertising achieved strong growth on a year-over-year basis due to strong performance from our ad-based model as well as lower advertising revenues for compression in Q2 2022.

The neo 618 E-commerce sales even generated a higher demand for advertising and contributed to a sequential increase in advertising revenues. We continue to explore new products and formats to offer more diversified options for our advertisers and remain confident about the long-term growth potentials in our advertising business. Social entertainment services and other revenues were RMB3 billion, down by 25% year-over-year. Starting from the later part of the second quarter of 2023, we have proactively implemented several adjustments to live streaming functions and certain risk control measures, including more stringent requirement for companies intended to offer better music-centric user appearance. These measures have negatively impacted our live streaming revenues this quarter, and we expect the negative impact to continue in the second half of 2023, resulting in a lower than previously expected revenues for full year 2023.

Lastly, we believe these measures are less and are beneficial to our users which will help lay down a healthier and a more sustainable foundation for our long-term growth. Gross margin in Q2 was 34.3%, up 4.4 percentage points, year-over-year, primarily due to the following factors. First, Online music services have shown strong growth momentum with high-quality growth of music subscription revenues driven by the continued uptick in online music paying user base and ARPPU and a robust growth in advertising revenues. Second, as we gradually ramp up our own content, it has a positive impact on the margin and will continue to be a favorable factor for our margin. In addition, the continuous improvement of operational cost efficiency also contributed to the increase in gross margin this quarter.

Now moving on to operating expenses. Total operating expenses for Q2 were RMB1.3 billion or 17.2% as a percentage of total revenues down by 3.3% from 20.5% as a percentage of total revenues in the same period last year. Sales and marketing expenses were RMB211 million down by 30% year-over-year as we have optimized our promotion strategies by reducing user operation spending, monitoring the ROI of each promotion channel and bringing more focus on high-quality paying user growth. With the effective promotion measures, we have seen significant growth in subscription revenues this quarter. General and administrative expenses were RMB1 billion, down by 6% year-over-year. This decrease was primarily due to a decrease in employee-related expenses as a result of improved headcount expenses.

Expenses related to our application for secondary missing last year also contributed to the year-over-year decrease. We continue to closely manage employee-related expenses by improving headcount visits and invest in search and development to further empower music-related content creation, enhanced production defenses and improve some quality and effects. Our effective tax rate for Q2 was 12.2%. For Q2 2023, our net profit and net profit attributable to equity holders of the Company were RMB1.3 billion. Non-IFRS net profit and non-IFRS net profit attributable to equity holders of the Company were RMB1.6 billion and RMB1.5 billion, respectively. Diluted earnings per ADS was RMB0.82 up 55% on a year-over-year basis. Non-IFRS diluted earnings per ADS was RMB0.97, up 54% on a year-over-year basis.

As of June 30, our combined balance of cash, cash equivalents and term deposits were RMB30.5 billion as compared with RMB28.5 billion, as of March 31, 2023. The increase was primarily due to strong cash flow generated from operations of RMB2.1 billion for the second quarter of 2023. Such combined balance was also affected by the change in exchange rate of RMB to USD at different balance sheet base. In conclusion, our music subscription business has demonstrated significant growth trajectory propelled by quality growth in both ARPPU and paying users and we expect such momentum to continue with clear focus on user experience and monetization. We will continue to invest in new products and services include high-quality content differentiated premium packages with appearing beverages and new technologies such as AIGC through organic development and to codify our foundation for long-term growth.

This concludes our prepared remarks. With that, I’ll turn the call back to Kar Shun.

Kar Shun Pang: Thanks, Shirley. Before we enter the Q&A session, I would like to take a few minutes to express our gratitude to Tony. During his tenure, Tony played a key role in our two successful public listings and contributed his professional expertise to advise TME’s post growth development. We really appreciate Tony and his team’s excellent work and valuable contribution to the group. Thank you, Tony. Now we are ready for questions. Operator, please.

Q&A Session

Operator: [Operator Instructions] Okay. Our today’s first question comes from Alex Yao from JPMorgan. Alex, your line is open. Please go ahead.

Alex Yao: Thank you, management, for putting us through the fundamental development during the quarter, and Tony best wishes to your future endeavor. My question is around the revenue outlook given the very different dynamic between music and social entertainment business. Can you elaborate a bit more on the underlying assumptions of these two segments in the next couple of quarters? And then I have related follow-up question, if we take a multiyear view, should we think of the nature of this risk management initiative as a permanent loss of certain high-risk revenue streams, so such that you have at least four quarters of rebasing period?

Kar Shun Pang: Okay. Thanks, Alex, for the questions. And I will take the first part regarding the revenue outlook and maybe Tony can take the second part of the question. This quarter, our online music services revenue contributions, which nearly 60% representing a significant growth from only 30% five years ago. So looking at the revenue contribution of our subscription businesses, it has surged from 80$ five years ago to 40% this quarter. So this progress really demonstrating that since we go IPO, our TME has been continuously expanding and solidifying our core online music business. This is where our long-term development is built upon and the exact reason why we are confident of our solid development for this year and beyond.

Looking ahead to the second quarter of 2013, our online music business is expected to maintain a robust growth strengthened by both paying user growth and ARPPU expansion for the subscription business, as well as the continued advertising and merchandise business expansion. This robust growth will be a stronger driver to both of our top line and also bottom line. Meanwhile, our social entertainment service will be expected to continue facing some pressure on its revenues due to adjustments related to certain live streaming functions. Nevertheless, very any major unexpected events, we anticipate that the impact level of this adjustment be stabilized by the end of Q3. And subsequently, monthly revenue in Q4 will be comparatively stable on a month-to-month basis.

So therefore, we expected the total revenue for this year will decline by low to mid-single digit per percent year-over-year, but our full year profits and profit margins, we see further improvements. So at the group level, I think our development strategy is focused on exploring the diverse business opportunities in the music arena and discovering the long-term growth potentials. As for our social entertainment services, our current goal is to maintain stable business scale. Although social entertainment revenue is currently facing some pressure when compared to five years ago, but we now have more resources and a growing accumulation of industry insights to strategically plan for the group’s long-term development. So, we believe that the adjustment made to our live streaming business will allow us to unlock the next level of development on more solid footing.

Tony Yip: Thank you, Kar Shun. That’s a fairly elaborate answer. The only thing I’d add is that the social entertainment services revenue adjustment took place in the later part of Q2, which means that, that downward pressure will continue into the second half which effectively resets the level of the social entertainment revenue at a low level. However, barring any significant unexpected events, we currently do anticipate that impact level of these adjustments to stabilize by the end of Q3. And therefore, a month, we expect monthly revenue for social entertainment services to stabilize on a month-on-month basis in Q4. Yes, I think that’s the only thing I can.

Operator: And our next question comes from Lei Zhang from Bank of America Merrill Lynch. Lei, your line is open. Please go ahead.

Lei Zhang: Thanks for taking my question and the best wishes to Tony on your new journey. And if I may want to follow up on the social entertainment set, can you give us some — the rationale behind this significant adjustments? And how should we look at the social entertainment segment outlook for the full year? And when do we expect the revenue growth to bottom out?

Tony Yip: Yes, I think the motivation behind these adjustments are to create a more music-centric live streaming atmosphere for our users. And these adjustments include stricter compliance procedures and also adjustments in certain live streaming functions. It enables us to better control potential risks that the platform may face in the future. And so even though these results in significant short-term pressure on our revenues, we see these as necessary in order to provide a solid foundation for our platform’s healthy development in the long run. And I think, like I said, I think in terms of outlook for the social entertainment revenues, it effectively reset it at a lower level, although the impact of that is likely going to stabilize by the end of Q3 so that when we look at each month in Q4, monthly revenues for social entertainment services are likely to be relatively stable on a month-to-month basis within Q4.

Operator: And our next question comes from Alex Poon from Morgan Stanley. Alex, your line is open. Please go ahead. Thank you.

Alex Poon: All the best, Tony, to your next journey. My first question is, congratulations on reaching the 100 million paying user milestone. Can management share your next targets, one or two targets for your subscription business and the timing of that target? And my follow-up question is regarding our share buybacks and dividends, if any, consideration. Thank you.

Tony Yip: On the subscription side, we continue to expect the subscription revenue to grow at a healthy trend driven by a number of factors. And frankly, I think many of these have been our results of years and years of hard work. I think from a kind of top-down perspective, we spent years of market education, encouraging users to develop a music consumption mindset to support corporate music we have continued to refine our operational strategies, enrich user privileges such as cell quality and sound effects. As a result, we are seeing a gradual shift towards increasing willingness to pay for music services as well as for our privileged product features. On the ARPPU side, as we mentioned for several quarters now, we will continue to follow our strategy towards optimizing our promotional discounts, gradually reducing them and to enhance the user’s perception of the value that they’re paying and for those users who are — who have higher expectations for cell qualities and additional demand for salaries we do have other premium product options at a higher price point, right besides VIP as well as other IoT memberships.

We also launched premium packages that are tailored to couples, for example. And so I think as we continue to see increasing willingness to pay among the user group, we are confident to be able to continue to grow the paying user, both the paying user and ARPPU at a healthy pace to drive the subscription revenue moving forward. And then on buyback, obviously, I think we have announced the buyback as you saw, we haven’t conducted a buyback to date but we will be actively looking for opportunities to do so if the right opportunities present itself, especially in times of share price weakness.

Operator: And our next question comes from Lincoln Kong from Goldman Sachs. Lincoln, your line is open. Please go ahead. Thank you.

Lincoln Kong: All the best to Tony as well. So, I want to ask about AIGC. I think management emphasized the importance of AIGC to our platform and to our business. Could management elaborate a bit more on the latest development of AIGC tools or the large language model we are currently leveraging how we think about the whole AIGC to empower of our business?

Ross Liang: [Foreign Language]

Tony Yip: Okay. I’ll provide a brief translation. We’ll continue to ride the wave of innovation that are brought to us with AIGC. While there has been a lot of focus on large models, our own focus more on the application layer, which are primarily twofold on either the content side or on user interaction side. On the content side, we will work on providing productivity tools to assist musicians to become more efficient with the music creation. Whether or not, we will see one day a fully automated end-to-end solution remains to be seen, but that’s something we would continue to monitor we are working on and starting to provide synthetic voice creation, which where users can pay to use AI to create their invoice to sustain and to do other things.

And then finally, we are using AI capabilities to dramatically shorten our R&D time. On the user interaction side with Xiaoqing, which we mentioned previously, it’s a companion that guide your music journey. She can recommend songs to you. She can chat with you and tell you her views of particular songs. She can also comment on individual songs. On the live streaming front, we are able to use AI to instantaneously create a customized virtual gift based on the worst that users type in so that every user can create a very unique virtual gift and use that to give to their favorite live streamer. And then finally, we are working on a new product called [indiscernible], which are similar to a feature where users can chat with various AI characters.

Operator: Thank you. And our question comes from Alicia Yap from Citicorp. Alicia, your line is open. Please go ahead.

Alicia Yap: Can you hear me okay?

Tony Yip: Yes.

Ross Liang: Yes.

Alicia Yap: Okay. Also all the best to Tony. So can management share with us what should we expect for the gross margin in the coming quarters. With online music now contributing also higher proportions of the revenue and then social entertainment continue to face the ongoing pressure. What is the net profit trend for the rest of 2023 and overall 2023?

Shirley Hu: Okay. Let me first talk about the gross margin. On gross margin, is 34.3% in Q2 increased by percentage year-over-year due to some factors as follows. First, online music services have shown strong growth momentum with high-quality growth to music subscription revenues driven by the continued uptick in the online mute paying user base and monthly ARPPU. And second, the robust growth of advertising revenues. And third, our self-owned content gradually ramp up. That has a positive impact on our gross margin and will continue to be a favorable factor for our gross margin. And fourth, we optimized the content cost model of RC and increase our requirement of content costs this year. And the fifth, license cost of long-form audio decreased at a year-over-year basis.

And sixth, the optimized the technology and operation strategy related to bandwidth and storage capability and improved the utilization of our service and equipment. Our gross margin has improved for five consecutive quarters. Looking forward, we expect subscription revenue and advertisement revenue will continue to be strong growth. On the cost side, we expect our in-house made content will have a positive impact on gross margin continually and we will continue to increase our operational efficiency and monitor cost items by our model. Despite the live streaming revenue will be decreased significantly in Q3, we expect our gross margin will be increased sequentially, and gross margin in 2023 will be higher than like in 2022. And now we move to our OpEx, we continue focus on improving our efficiency of OpEx in 2023.

Over the past quarters, our ROI-oriented marketing strategy has grown successfully. In selling costs and enhanced efficiency. Our sales expenses declined year-over-year for the sixth consecutive quarter, thanks to effective management of sales channels ROI and a well-balanced allocation of international and external — internal and external resources, and we will remain committed to this principle. We anticipate a continued year-over-year decrease in selling and marketing expenses. We will also further refine our operations, enhance headcount efficiency paying more attention to improve the profitability of business and products, adjust the headcount according to profitability business. Meanwhile, we are continuously monitoring new opportunities within the content ecosystem and cutting edge technologies and invest in such areas.

Looking forward to the live streaming revenue will decrease significantly. So we anticipate our adjusted net profit will be around stable at year-over-year and adjusted net profit margin will increase. We also anticipate that adjusted net profit and margin all will increase at a year-over-year basis in the second half year of 2023.

Operator: And our next question comes from Thomas Chong from Jefferies. Thomas, your line is open. Please go ahead. Thank you.

Thomas Chong: Thanks management for taking my questions and all the best for Tony. May I ask a question regarding our content strategies? Given the solid results we achieved in our original content. Can management comment about the strategies going forward?

Ross Liang: Thank you, Thomas, for the questions. And as a leading music platform in China, I think one of our key focuses is discovering and also cultivating the talented musicians and encouraging them to create more music. We’re also assisting them in promoting their work on our platform. We are so delighted to witness that the continuous increase in the proportion of original content on our platform nowadays, other use of investment and coloration and is increasingly good. So the increase has also contributed to our margin expansion as well. Leveraging our comprehensive resources and technological capabilities, I think that in TME, we are actually offering a holistic support to all of the artists. Firstly, the Tencent musician platform, as we mentioned before, they always offers off-line performance opportunities and also exposure and launches fill program to encourage the innovative content production.

It also provides various commercial opportunities as well including the royalty, online in digital album sales and overseas distribution. So, all these are all solid means of support for the artists. Secondly, our all-in-one music production and promotion platform winners is designed for producing and transacting the demo and also the work, it has attracted numerous content creators and music labels selection promoting resources, consolidation efficiency. In addition, I think we also collaborate with a well-known domestic and international IPs to attract a broader audience and expand TME’s industry influence. For instance, in the gaming sector, we have jointly created theme songs with Tencent’s [indiscernible]. And in the innovation and theme, we have also partnership with the popular IP, like the land of ores and the Spider Man.

And all of these are really exciting content development project that we have online right now. In terms of the online production promotions, we have a wealth of internal and external resources. Internally, we have the three major user platforms and also externally, we can work with the Tencent ecosystem, for our operating collaboration with the [indiscernible], and we can promote on the [indiscernible] official account and rating video account to reach a massive user base as well. And last but not least, we’re also helping our talent provider to do the music distribution to overseas market as well through our TME music house service, which I think is very meaningful to help promoting Chinese original music in the international market as well.

Operator: Thank you. And we will take our last question today from Xueqing Zhang from CICC. Xueqing, your line is open. Please go ahead.

Xueqing Zhang: Thanks management for taking my question, and also my question and also best wishes to Tony. Just a quick question on IoT. Do you have any color service progress such as mentalization and revenue contribution?

Ross Liang: [Foreign Language]

Tony Yip: So within IoT, our current main focus is in car services, especially smart cars, which we believe will be a huge market, primarily domestically, but also to some extent, overseas fear jokes. Music, as you know, will be a prime entertainment use case within smart cars. And through our premium side effects, such as our partnerships with Adobe, we stand well positioned to benefit. We also have deep cooperation with a broader set of car makers and we’ve launched QQ Music’s 2.0 version that are dedicated for in-car services. As a result of all these efforts, both our in-car music users as well as revenues are seeing rapid growth. And as an example, during the May holiday, where there — we’ve seen a significant increase in holiday and time spent during cars, we have seen a significant uptick in music consumption and spending.

And as a result, over the long term, we’re very optimistic that IoT, specifically car services will provide us with good opportunity for subscription and revenue going forward.

Operator: We are approaching the end of the conference call. I will now turn the call over to our host, Mr. Tony Yip, for closing remarks.

Tony Yip: Well, here is to close our call for today. I just want to extend my personal thank you to all of the senior management team at TME as well as the Company and the Board for the trust in me throughout the years. It’s been an incredible journey, and I’m incredibly proud of everything we’ve achieved together over the past five years.

Ross Liang: Thank you, Tony.

Tony Yip: Thank you everyone.

Kar Shun Pang: Thank you. Take care.