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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Ladies and gentlemen, thank you for standing by, and welcome to YY Incorporated Third Quarter 2018 Earnings Call. [Operator Instructions]. I must advise you that this conference is being recorded today, Tuesday, the 13th of November, 2018.
I'd now like to hand the conference over to your speaker host today, Mr. Matthew Zhao, IR Director of YY. Thank you. Sir, please go ahead.
Thank you, operator. Good morning, and good evening, everyone. Welcome to YY's third quarter 2018 earnings conference call. Joining us today are Mr. Bing Jin, Chief Financial Officer of YY; and Ms. Ting Li, Chief Operating Officer of YY. For today's call, management will first provide a review of the quarter and then we will conduct a Q&A session. The third quarter 2018 financial results and webcast of this conference call are available at ir.yy.com. A replay of this call will also be available on our website in a few hours.
Before we continue, I refer you to our safe-harbor statement in our earnings press release, which applies to this call as we will make forward-looking statements. Finally, please know that, unless otherwise stated, all figures mentioned during this conference call are in renminbi.
I will now turn to the call over to Mr. Bing Jin, CFO of YY to provide you an update on behalf of our Chairman and acting CEO David Xueling Li. Then he will also go over the details of our financial results of the quarter. Please go ahead, sir.
Thank you, Matthew. Hello, everyone, welcome to our third quarter 2018 earnings conference call.
Our total revenues increased by 42.6% year-over-year to RMB4.1 billion during the third quarter, exceeding the high end of all previous guidance range. Revenue from our live streaming business grew by 35.6% year-over-year to RMB38.9 billion. Revenue from Huya, our game live streaming subsidy grew by 118.8% year-over-year to RMB1.28 billion.
Today, we're very pleased to announce that we have entered into a strategic cooperation agreement with Xiaomi in late October. Under this arrangement, YY has the exclusive right to operate certain entertainment live streaming services on Xiaomi's primarily live streaming platform Xiaomi Live. This agreement will enable us to integrate both our high quality live streaming and extensive experience in life streaming operations into Xiaomi's ecosystem.
We are confident that the cooperation will provide Xiaomi's users with a better experience in entertainment live streaming services and enable YY and Xiaomi to explore additional monetization opportunities together. Going forward, we will maintain our open approach to the development of multi-platform cooperation. By leveraging the user traffics of our partners, we will introduce more innovative live streaming services to the market, thus creating multiple benefits to all the parties involved.
During the third quarter, we continue to execute our growth strategies on three key areas, content enrichment and upgrades, produce enhancements and overseas market explosion, and high AI-backed technology enhancement. Improvements in these key areas translates into enhancement in both user growth and stickiness, which in turn will create more potential monetization opportunities.
Firstly, we continue to acquire and retain users from content enrichment and cross-channel promotions. During the third quarter, while we continue to reinforce the popularity of Modern Brothers and expand their fan base, we also try to replicate their success formula with other hosts. We have systematically incubated, groomed, packaged, promoted and transformed a series of Glasgow's musicians into bonafide music stars.
In addition, we recently upgraded our YY musician program by teaming up with one of the leading music platforms in China to better promote artists who have displayed original production skills across both our home grown channels and our partner channels. Not only are we successful in promoting our host online, but we also created in cementing their fame offline.
In September 2018, we hosted the YY Fan Carnival in Guangzhou, bringing together over 300 top tier live streaming hosts to produce a super verity show, integrating music, dance, gaming and many other entertainment programs into a single event that lasted three days. Over 250,000 fans participated in this event in person. More than 11 million viewers turn into the online broadcast. At the peak show time, the concurrent online viewer count exceeded 1.6 million. These successful events demonstrated that YY has been recognized as one of the most influential, sticky and mature online cultural communities in China.
Secondly, during the third quarter, we also focused on continuous product enhancement. As the leader of the live industry in China, we continue to expand our product make magic and redefine the boundaries of live streaming services from video based live streaming content to more diversified categories including interactive audio based on live streaming. As a result, we have developed several products focused on audio live streaming. By infusing more social features into audio live streaming products, we will continue to explore the best model to provide audio live streaming services to the next generation of mobile users in China.
In addition, we are very confident of the significant growth potential in overseas markets. We have already initiated the overseas operations for several of our early stage innovative products. Going forward, we expect to increase spending on our overseas these expansion in order to achieve more rapid user growth and explore more monetization opportunities for these products.
Thirdly, we leverage our proprietary algorithms to further increase our use of stickiness which in turn translates into a longer user time spend and better monetization. Utilizing our deep neural network technology to quantify the level of interaction between host and fans, we successfully motivated our hosts to constantly produce new and engaging content to boost or sustain their popularity ranking. Meanwhile, through our AI infused visual recognition technology, we automatically capture the most infilling scenes from live streaming shows and use them as our front page or recommendation page from those to increase user click through rates. As a result, our average user time spent on YY Live has increased doing this quarter compared to last quarter.
Overall, as the macroeconomic environment remains uncertain for the rest of the year, we will continue to focus on enriching our content, enhancing our user engagement and improving our monetization capabilities.
We are very confident that with our strong competitive edge, lower user base and innovative spirit, we're well positioned to weather through any market conditions.
That conclude the remarks of our Chairman and acting CEO, David Xueling Li Schilling. Now as the CFO of the company, I would like to discuss our financial results in more details.
During the third quarter of 2018, we continue to deliver strong financial and operating metrics. Our total net revenues for the fourth quarter increased by 32.6% year-over-year to be RMB4.1 billion. Specifically, our live streaming revenues increased by 35.6% year-over-year to RMB3.89 billion accounting for 95% of our total net revenues this quarter.
Our ongoing efforts and investment into our mobile platform and related technologies have also continued to yield impressive results. In the third quarter, mobile contributed 62.4% of our live streaming revenues, while mobile live streaming MAUs increased by 20.7% to 88.1 million in the third quarter 2018.
Live streaming paying users increased by 26.3% to 8 million in the third quarter 2018, while mobile paying users constituted 73.9% of overall live streaming paying users.
Cost of revenues on the third quarter increased by 41.6% year-over-year to RMB2.65 billion. The increase in revenue sharing fees and content costs paid to performers, guilds and content providers was in line with the increase in live streaming revenues for both YY Live and Huya segments respectively.
In addition, bandwidth cost for the third quarter increased to RMB249.5 million, primarily reflecting continued user base expansion and live streaming quality improvements.
Gross profits for the third quarter increased by 18.5% year-over-year to RMB1.43 billion. Gross margin was 34.8% compared to 38.9% in the prior year period, primarily due to the increase in revenue sharing fees and content cost. In addition, Huya's relatively low gross margin negatively impacted our overall gross margin as Huya's contribution to our net revenue increase significantly year-over-year.
Our operating expenses were RMB864.7 million during the third quarter of 2018 compared to RMB$560.3 million in the prior year period, primarily due to our increased investment in talent recruitment as we further enhanced our research and development capabilities.
Sales and marketing expenses for the third quarter were RMB343.8 million or 8.4% of total revenue compared to RMB249.5 million or 8.1% of total revenue in the prior year period. Our R&D expenses for the third quarter were RMB314.1 million or 7.7% of total revenues compared to RMB156.1 million or 5.4% of total revenues in a prior year period.
G&A expenses were RMB206.7 million or 5% of total revenues in the third quarter compared to RMB144.7 million or 4.7% of total revenues in the prior period.
Our GAAP operating income for the third quarter 2018 was the RMB610.9 million compared to RMB661.4 million in the prior year period.
Our non-GAAP operating income which excludes share based compensation expenses, impairment of goodwill and investment and gain on the consolidation and disposal of a subsidy increased by 12.9% year-over-year to RMB774.2 in the third quarter of 2018.
GAAP net income attributable to YY increased by 2.3% to RMB650.7 million in the third quarter 2018. Our non-GAAP net income attributable to YY increased by 19.7% year-over-year to RMB787 million in the third quarter of 2018. Non-GAAP net margin in the third quarter 2018 was 19.2% compared to 21.3% in the prior year period.
Diluted net income per ADS in the third quarter 2018 was RMB10.01 compared to on RMB10.51 in the prior year period. Non-GAAP diluted net income per ADS increased by 11.1% to RMB12.07 from RMB10.86 in the prior year period.
Looking forward to the fourth quarter of 2018, we expect our net revenues to be between the RMB4.39 billion and RMB4.54 billion representing a year-over-year increase of 21.1% to 25.2%. This forecast reflects our current and preliminary views on our market and operational conditions, which are subject to change.
That concludes our prepared remarks. Operator, we would now like to open the call to questions.
Thank you so much. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] And our first question comes from the line of Thomas Chong from Credit Suisse. Thomas, you line is now open.
[Foreign Language]
Thank you very much for taking my questions. I have two questions. My first question is about our 2019 outlook as well as our overseas expansion strategy for next year? And my second question is you about Bigo. Given that, I think we have talked about the revenue for user and the geographical rate some time ago, can you give us some color about the latest business trend? Thank you.
[Foreign Language]
Okay, in terms of the outlook for the year of 2009, firstly, if we look at the domestic market in terms of both of the user growth as well as revenue growth, we are still quite optimist on that. And secondly for YY as a whole, we actually continue to develop more opportunities in the oversea market and we have launched several of the new initiative product in the international market. And what we're trying to do is have more synergies with Bigo's business together and trying to continually improve the user as well as tapping into the new markets.
And Thomas, I will take your second question. So with regard to the updates of Bigo, in the third quarter, Bigo’s revenue continue to grow very strongly. While they are further consolidating Southeast Asian markets, they also exploring more rapidly into other developed areas such as U.S., Australia, Japan et cetera because these market has huge potential as well. Certainly, Bigo has a business unit called Like, which is shop-on-video app. We are glad to see that the user base for Like continue to grow very heavily in the third quarter, particularly after we have integrate a lot of AI-driven algorithm to drive the user retention rate. The general user number and revenue as we discovered before hasn’t changed in terms of forecast.
Thank you.
[Operator Instructions] Our next question comes from the line of Eileen Deng from Deutsche Bank. Eileen, your line is now open.
[Foreign Language]
My first question is regarding the paying users, we saw some sequential growth where will have paying user on third quarter, what drives this recovery and how should we expect the trajectory going forward under the macroeconomic conditions and also our effort on the cooperation? What are the tactics can help to achieve the further growth?
And the second question is, could management elaborate more on the cooperation with Xiaomi, what is the each party’s role and when should we expect the clear revenue and contribution from it? With other potential new partnerships, should we expect, is it from the smaller live streaming platform or other kind of a platform? Any color will be helpful? Thank you.
Thanks, Eileen. I’ll take the first question and Ting can take the second one. In terms of the paying user growth, we do see a healthy growth in the third quarter, probably due to several reasons, one is, we continue to add new features and also we have integrated some of the operation activities to drive the paying user behavior. Currently, we have also as I said integrate lot of the AI-driven mechanism in terms of matching the best quality content, the best clear content to the right audience, so that whenever they view the content, you feel more comfortable and whenever they pay, they feel more comfortable. In the future, we will continue to add new features and also we’ll continue to integrate more and more AI machine learning capabilities, hopefully to continue to drive the paying regional. As I said to many investors and analysts before, in terms of paying ratio, we still have massive room for growth compared with game paying ratio in general.
[Foreign Language]
Let me give you more details in terms of why cooperation with Xiaomi. Firstly Xiaomi actually is one of the all sorts of the China’s for our continuously user growth going forward. So in terms of our cooperation and philosophies with Xiaomi, firstly, we look at why it’s very strong of the monetization efficiency as well as monetization capabilities. So throughout the Xiaomi’s cooperation, we actually export very efficiently of the monetization capabilities for other platform. Secondly, we also look at the traffic synergies between YY and other platforms. So working with our partners together we’re actually continue, expand the overall market pie as well as to improve the conversion rate from our partner’s platforms. And meanwhile, because of Xiaomi’s cooperation will be officially launched in December, so we are still in the variety stage. So we’ll probably will provide more colors going forward. Thank you.
Thank you very much.
Thank you so much. And our next question comes from the line of Karen Chan from Jefferies. Karen, your line is now open.
[Foreign Language]
My first question is actually regarding the management share, the revenue contribution approximately from our top paying uses currently YY Live and also how – what are we doing differently for new gala this year compared to last? And finally, how should we think about margin trajectory for 2019 and beyond? Thank you very much.
Thank you, Karen. Let me take those questions. So first one is regarding constitution of the top donors, the general patterns haven’t changed much as we say many times, that’s a typical phenomenon in all the live streaming platform in China. But we’re seeing gradually improvement in terms of the de-constitution for the top donor, even though the percentage change isn’t that much.
With regard to the new gala, we will continue to launch gala event this year, however the focus will be shifted from encouraging the big deals to donate into encouraging long help deals to participate and encouraging long deal host to flourish. We do think that is more healthy throughout acquisition in the long run, because for the deals they also have the on P&L pressure. So we don’t want have them spend all the money to earn probably so that’s regarding gala. For the margin, for the expansion, we will spend some of that I will say sales marketing at the right time to promote overseas products. But again as overseas business continue to grow, we’ll see more and more economic scale. So I would encourage you to use the most recent quarter kind of margin at the basis. Of course our overseas business has many other dimensions and variable, so we can’t comment too much at this stage.
Thank you very much.
Thank you so much. And our next question comes from the line of Jialong Shi from Nomura. Jialong, your line is now open.
Hi. It’s Jialong Shi from Nomura.
[Foreign Language]
So my question, I have a follow-up question on the Xiaomi partnership. In particular, I just wonder how many Xiaomi phones will this cooperation cover and also what is the economics for such cooperation? Will YY need to pay pre-installation fee to Xiaomi or is a revenue sharing model? And also I just wonder if YY will be exclusive provider for entertainment live broadcasting contents on those Xiaomi phones? That’s my question?
[Foreign Language]
In terms of – let me provide you more colors in terms of our cooperation with Xiaomi. Firstly, for Xiaomi is MAU systems, they actually has over 200 media of MAUs. So it’s the potential user base can be much bigger and it’s a part which is we cooperate which is called the Xiaomi Zhibo or the Xiaomi Live is one of the most important of the live streaming platform into Xiaomi’s platform. And we actually have the excessive cooperation of which Xiaomi Zhibo together so far especially in terms of the entertainment in the live streaming content.
And for the economic scale going forward, we actually we’re using the revenue scale or revenue sharing model rather than pay the upfront fee in terms of the user acquisition. So I think the two parts of the demands going to be alike and so we are trying to make the potential market size bigger than we will sharing of the revenue as well as a profit for this corporation. And last I mean in terms of the Xiaomi’s penetration, Xiaomi Zhibo’s penetration to the whole Xiaomi ecosystem is relatively small. So going forward, followed by our cooperation to show more approach to the Xiaomi’s ecosystem, definitely we inspired it our traffic which is weaker apart from the Xiaomi’s ecosystem will continue increased. Thank you.
[Foreign Language]
Thank you so much. And our next question comes from the line of Natalie Wu from CICC. Natalie, you may now ask your questions.
[Foreign Language]
So first question is regarding can management team has some color around, what kind of initiatives have we prepare for next year, to drive up our core MAU and paying user? And second question is the margin outlook came in the revenue sharing agreement with Xiaomi? Thanks.
So looking into the 2019, firstly, since we already see it’s a very healthy of the user number of growth from our overseas initiatives products. So looking into 2019, will continue Huya into the overseas user acquisition as well as the product enhancement.
And then secondly, followed by the Xiaomi’s cooperation, we will continue looking for other traffic of the potential partners in the domestic market. So continue expand our cooperation with other the potential demotic partners going forward to expand our channels as well as bring more monetization opportunities going forward.
Thirdly, otherwise core apps, we actually also give up another [indiscernible] which is means the simplified of the version of YY. So comparably, it has a smaller size of the package, it’s most suitable for the lower end of the phones consumption. So that product actually is more simple for the lower tier safety or the lower end of the users consumption. And looking into 2019, we also will continue to promote, our simplified version into more wider range of the potential market in the domestic China.
And the fourthly, since previously we all – for YY, we always focused on the video live streaming of the business. But in 2018, we actually also developed several of the opportunities in terms of audio live streaming in China. And we trying to combine those kinds of products into a united platform and we also looking for more monetization opportunities for the audio live streaming services. So looking into 2019, we’ll continue to web other more diversified the content offerings as well as the services through the audio live streaming services. Thank you.
Let me address the second question regarding the gross margin trend regarding from Xiaomi cooperation. I think in general, it’s too early to say how is the margin trend will be going resulting from the Xiaomi cooperation, because we just started the cooperation and the accounting treatment need to be finalized at a later stage. Again the key strategy value of this cooperation is to setup perfect example in China how we can export our core competency in licensing and partner with a big traffic platform. And hopefully we can continue to replicate this kind of model to other platforms as well. So I think let’s wait and see is still early in terms of the marketing trend.
[Foreign Language]
Thank you so much. And our next question comes from the line of Jerry Liu from UBS. Jerry, your line is now open.
Thank you, management. Just have a two quick follow-ups. The first one is the on Xiaomi and similar smartphone cooperation, if we look at this just in aggregate, do we see some revenue contribution in 2019? And then the second, I just wanted to go back to a topic we spoke about on our recent earnings calls which is exporting our content to other platforms. For example, like Modern Brothers and we just got an update on how foreseen traction and how that is attracting new users or returning users to YY, any updated statistics there? I’ll translate.
[Foreign Language]
Jerry, thanks. I’ll take the first question and Ting Li will take the second one. In terms of company with Xiaomi and other partners and their revenue contribution into 2019, again it’s too early to say, but I think that what they will be contribution in terms of revenues for 2019. How big the scale is depending on the progress with Xiaomi and how soon we can replicate to other platforms
[Foreign Language]
Yeah, let me talk about more in terms of our strategies to promote our top host. So as being described in the conference call and meanwhile in the third quarter, we actually continue to export a series of our host into other platforms. Firstly, we continue to upgrade of voice musician programs into more platform. So what we need is we’re trying to how our top host to publish the popular singles and into the other platform. Then we were doing publish of those kind of single sounds with other music platforms in China together. So what we’re trying to do is through our effort with the host together, we continually improve their influence in both internal platform as well as external platform then continue to explore more monetization opportunities for those kind of top host other top musicians in our platform.
Then secondly, in the third quarter, we saw for the Modern Brothers we also – as I mentioned before, we also are trying to promote a series of other artist [indiscernible] those kind of the new names you probably never heard before. But through of our export of the – those kind of UGC of the content, all the music products, we went through of our matured of the marketing activities, actually we continue to promote those kind of host into other platforms. So in general speaking, we will continue to do more efforts and what we’re trying to do is just bring systematically experience, and then we’ll continue apply that in to more potential host in our platform going forward. Thank you.
Okay. Thank you.
Thank you so much. [Operator Instructions] And our next question comes from the line of Hillman Chan from Citigroup. Hillman, your line is now open.
[Foreign Language]
So my first one is also to follow-up on the Xiaomi cooperation. What we have to – why have to bear with the extra cost on advertising or these acquisition costs, Xiaomi Live or with those Xiaomi keep that? My another question will be also on the outside of live streaming and do we have any other initiatives that you can update us on regarding for example of some video, games and else? Thank you very much.
Thanks, Hillman. I’ll take the first one and Ting Li will take the second. With regard to our cooperation with Xiaomi, again Xiaomi will be responsible for their user acquisition cost. Remember, all the front end will be within Xiaomi. We’ll just take up the backend and export our core competence in terms of managing the deals, managing the content, managing the live streaming business for them. But the front end will be managed by Xiaomi that means including the app itself, including how they attract users. So we don’t bear the additional cost with regard to that.
[Foreign Language]
Let me discuss more in terms of the new products initiatives. Except for the social games platform as well as short-form video platforms, we actually also more actively to give up various of the different functionality based of the products in oversea market. But our focus is not only on the user growth, what we’re trying to do is also exploring more mix of material of the monetization model for those kind of a new products. So definitely one, we think the time is ready, when we feel comfortable for both of the user growth number as well as monetization philosophies, so we will disclose more numbers for you. Thank you.
[Foreign Language]
Thank you.
Thank you so much. And our next question comes from the line of [indiscernible] from Merrill Lynch. Please ask your question.
[Foreign Language]
My first question is, I just want to follow-up on the overseas markets. Do you see any major competition in this market and do you say the contents or the spending for the host is increasing in overseas market? And my second question is a follow-up of partner Xiaomi externals strategy, do you – is that – maybe you can any updates on the content allocation about your own platform on the Xiaomi platforms, is there any dilution of your content giving the host have the limited streaming time? Thank you.
[Foreign Language]
Let me answer your first question in terms of our overseas strategize firstly. So I think in terms of the year 2018 is probably the zero year for all the Chinese Internet companies are trying to develop their overseas business and put more effort on to that. So in terms of user growth as well as a user cost for the Southeast Asian market, we actually see the monitor also continue to cost growth on the year-over-year basis. But meanwhile, we also notice for most of the Southeast users, mobile users, they only use the main stream apps for example like Facebook or YouTube, which is mean these two has a lot of time as well as demands which is have not be fulfilled by the mobile apps. But they also as a very strong demand in terms of the online and offline entertainment demanding and they has to be fulfilled by the new products or some of the new initiative which is suitable for their consumption habit as well as cultures. So based on those kinds of document, we will continue develop more payer made of the functionalities of the products which is simple for the Asian users and a continued growth of user number in Southeast Asian markets.
And certainly in terms of the maturity of the host market in Southeast Asia market, you are right because we are compared with Chinese domestic markets definitely is much immature compared with domestic market. Although we note there has a lot of net rate of those kinds of all those in those kind of different regions and countries. But for most of them is still in the very early stage. They are not maturity, have no idea how they monetize of their influence or how they monetize of their traffic. So what they more need is a more material of the cloud waiting all the training systems for the host, for those kind of net rate of all as an opportunities and which is a stress from the widest past seven years of the execution capability.
So for YY, we actually has a very mature of the host counter waiting as well as the training system, where actually can export of those kinds of experience or the system into the Southeast Asian market and trying to develop more solid of the relationships with those kind of net ride all the potential host then continue to develop of their influence as well as, the monetization opportunities for them. Thank you.
[Foreign Language]
The second question in terms of Xiaomi’s impact of Xiaomi’s Live’s cooperation cannibalization towards them, based on our thinking is we don’t think we will have received a serious of the cannibalization or the impact from the Xiaomi’s cooperation. The major reason because if you look at the detail of the cooperation, we as partners will provide the tailor made of the content as well as the host into the Xiaomi’s platform based on the Xiaomi’s user base profile or Xiaomi’s Ecosystems. So what we do is based on the new – exactly new and the different of the user profile and to continue develop of the more entertainment live streaming services in Xiaomi’s platform. So from that perspective, definitely we will not see of the impact for YY’s own platform going forward. Thank you.
[Foreign Language]
Thank you so much. And our next question comes from the line of Alex Liu from China Renaissance. Alex, your line is now open.
[Foreign Language]
So for international vendors, we have multiple products in pipelines, just wondering is there anything that more related to social or more entertainment aspects in development and also for the – whether the management can help us understand more on the investment strategy as of today? Thank you.
[Foreign Language]
First, let me answer your first question. So the answer actually is quite a funky, so in terms of overseas product pipeline, we definitely have some of the new product which is focus on social future or the social connections or social net. But at the current stage, our key focus still will be the traffic acquisitions, then based on the users number where actually can develop more different ways to continue improve the user techniques as well as monetization. Thank you.
Second question regarding the past usage, we do have a lot of cash on hand even though super majority are sitting onshore which some offshore. We’ll continue to use cash on several fronts, first is develop new product to drive new traffic both in China and Globally. Second one is sales marketing whenever we have a good product, we need to find the right channel to have more audience pay attention to that new product. Thirdly, as we discussed before, we continue to look forward to M&A targets in China and globally for traffic content and good technologies.
Thank you so much. I would now like to hand the conference back to the management team for the closing remarks.
I think that’s the end for our call. We look forward to our continue discussing with everyone. Thank you for the time.
And that does conclude our conference for today. Thank you for participating. You may all disconnect.