Tencent Music Entertainment Group - Q2 2023

Transcript

Tony Yip (Chief Strategy Officer)

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. 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. Cussion 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, Miss Shirley Hu, our CFO, 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 Cussion, Executive Chairman of TME. Cussion?

Cussion Pang (Executive Chairman)

Thank you, Tony. Hello, everyone, thank you for joining our call today. We are 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. Many years, TME has been dedicated to driving the healthy development of China's online music industry. Following our long-standing efforts, we are pleased to see users becoming increasingly accustomed and willing to pay for copyrighted music, whether for songs they want to listen to or for the premium listening features they enjoy. Riding this wave, we are happy to see that our online music paying ratio and monthly ARPU reached an all-time high of 16.7% and RMB 9.7, respectively.

Such achievements drove revenues from this business pillar 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 music business model and marks a significant step along TME's growth path. Looking at our social entertainment services, starting from the later part of the second quarter, we have proactively implemented several service enhancement and risk control measures to provide users with a more music-centric live streaming atmosphere, as well as to reinforce risk controls.

While these measures are expected to put pressure on revenues from our social entertainment services throughout the second half of 2023, and thus 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 run. Moving on to our operation progress on content. As a key component, fostering our music ecosystem, our comprehensive content ecosystem sets us apart from other industry players. During the quarter, we continue pushing the wide senses of our content ecosystems 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 comprising of two music ceremonies and two music festivals, joined by a prominent lineup of over 80 well-known domestic and overseas musical groups and singers, such as JJ Lin, Lin Junjie, Jolin Tsai, Cai Yilin, Laure Shang, Shang Wenjie, Zhou Shen, Tia Ray, Yuan Yawei, and Seventeen. Being able to successfully organize such a large-scale offline performance of four music events over a single weekend, coupled with an exceptional lineup of musicians, demonstrates 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 a social media buzz of over 10 billion views, once again, creating a national music sensation. Furthermore, we remained the partner of choice for famous labels and artists on a wider range of content offerings and merchandise.

This enable us to provide music lovers a rich selection of music content and products, as well as a unique and trendy experience at TME. 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 cooperate with Jackson Yee, Yi Yangqianxi, on the release of his new physical album, Liu Yanfen, featuring a headstart release with TME. This partnership delivered an outstanding sales record of Liu Yanfen on our platform.... Another highlight was the debut of Chris Lee's, Li Yuchun's brand new digital album, Have a Nice Weekend, Zhou Mo Yu Kuai, plus the sales of her album's limited edition merchandise. In addition, we continue expanding our vertical music content to attract a more younger audience.

For example, Mintone Records, a key hip-hop label, recently joined our platform, adding over 440 songs to our hip-hop music library, some of which included 30-day headstart releases. On the front of up-and-coming musicians, we are helping new artists rise their visibility within the industry by providing critical technological assistance and integrated resources that support their growth throughout their entire music journey. In July, we upgraded Venus, our all-in-one music production and promotion destination, to better help indie musicians improve their efficiencies in producing, transacting, and promoting songs. Venus latest iteration have integrated our full suite of AIGC music tools into Venus. As an AI-enabled music separation, sheet music generation, lyric writing, and creations of cover for songs, significantly improving creators' efficiencies at each step of the music creation process and elevating their music quality.

Venus is also creating enhanced efficiencies of resources for consolidation as it gathers a wealth of demos on its platform and empowers convenient music transaction and promotion processes. Having attracted a diverse range of creators and labels, Venus has re-recorded music transactions with a total value of over RMB 10 million as of the second quarter. Furthermore, we leveraged our differentiated and comprehensive set of resources and opportunities to nurture up-and-coming musicians and foster creativities. For example, our Tencent Musician Platform strengthened 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 find commercial opportunities. In the second quarter, our Emerging Force program sent several of its emerging artists to seven offline music events.

We also offered more theme and indie band the opportunity to produce a theme song for BYD Car sales celebration event. Our deep involvement across the music value chain enable us to be in a 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 multifaceted interpretation, we provided comprehensive and pioneering insights, as well as case studies, aiming to promote healthier and more sustainable industry development. That concludes the overview of our second quarter and the progress we have made across our growing content capabilities. I'll now turn the call over to Ross, who will share more about our platform strategies.

Ross, please go ahead.

Ross Liang (CEO)

Thank you, Cussion. 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 it reflects our growing appeal to music lovers. As we see an increase in growth potential materializing from users' evolving music consumption mindset, we are continually elevating our music experience to meet users' higher standards and a stronger desire for quality. On top of the progress in our content ecosystem, as Cussion 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 listening 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 higher user engagement and stickiness to our platform. For example, QQ Music upgraded its series of QQ Music Audio, Zhenpin Yinzhi Yinxiao, to ensure optimal sound quality and effects, which are now also available in our in-car service. We also launched the QQ Music Audio Certification, which sets industry standards for sound quality across hardware devices such as earphones, speakers, music players, and car audio speakers, allowing access to superior sound quality among users in their daily lives. QQ Music also expanded in a 3D music player, offerings such as players customized for subscribers or designed for classical music to boost the product attractiveness and thus user use. In QQ Music flagship apps recently upgraded, we highlighted a more intuitive interface and an engaging, unlimited music discovery function.

QQ also unveiled its ViPER 3D, 奇趣全景声, bringing an immersive live concert-like listening experience to users. Furthermore, Weixin introduced a brand-new function in June that enhanced users' recording and singing experience, including optimized vocal details, enhanced balance between human voice and accompaniment, and a wider selection of sound effects, as well as recording skins. Coupled with these enhancements, we also strengthened our ability to recommend the music through refined user preference and analysis, and optimized our algorithms, allowing a convenient and individualized music discovery. All of these efforts contributed to higher DAUs derived from various recommendation scenarios and a larger portion of recommendation-related streaming share. In terms of listening 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 use case, we improved user experience across sound quality and effects, music recommendation, and interactive functions. For example, QQ Music launched its in-car version 20 in June this year, and forged partnerships with more car makers, such as SAIC, Volkswagen, FAW, Volkswagen, and Volvo, among others. We also expanded collaborations with more carmakers and embedded our in-car offerings in more car models, potentially tapping into a wider base of users, who then can enjoy a seamless native in-car music listening experience. Alongside the recovery of offline progress, driving times have length, thus increasing the use of in-car music services. As a case in point, during the Labor Day holiday period and 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 differentiated music entertainment experience for users through our AIGC endeavors, while fulfilling their desires for trendy, trendy features to keep up with the AIGC boom. On the online music side, we started to test AI-enabled listening together that allows Xiaoqin, our AI music companion, to join users' music listening journey, share a variety of topics, include their views on music, and recommend songs or playlists 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 listening experience. On the live streaming side, we innovated AIGC-enabled virtual gifts to facilitate a more trend-setting interaction between users and anchors.

Such virtual gifts can be automatically visualized quickly as users input text descriptions, promoting a more creative and a unique user-performer bonding during live streaming. All these efforts have in turn reinforced our platform's 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 consumption habits, promoting great prosperity across the music industry, while 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 (Chief Strategy Officer)

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, 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 trending topics or 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 RMB 9.7 in the second quarter. The ongoing uptake 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 our extensive relationships with more car makers and its applications in more car models. Online music services other than subscriptions also delivered robust growth as we further enhanced monetization. For advertising, our diversified product portfolio and innovative ad format remained highly attractive to advertisers across different industry verticals. Advertisers from e-commerce to 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 contests, Next Singer 2023, our signature music event, Wavemaker, QQ Music's Dianfeng Music Festival, and Kuwo Music's music festivals with barbecue-related themes. Such a portfolio of music IPs attracted Sprite, Tongyi Shuangcui, and 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 their albums and sales of various merchandise.

Moving to social entertainment services, as Cussion 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 Q3 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 introduced new localized features to boost engagement, showing satisfactory initial results in both penetration rate and time spent.

Last but not least, TME continued 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 held two Little Red Flower charity concerts, Xiao Hong Hua Gongyi Yinyuehui for Children. In May, we hosted the first concert to raise public support for children with hearing impairment. We helped seven hearing-impaired children replicate their own voices with our Lingyin Engine AI capabilities, then utilized their AI-generated voices to create and perform a concert along with several musicians. On Children's Day in June, we hosted another concert for children in rural areas, offering them a platform to express themselves through music while showcasing music aesthetic education in those villages.

These programs not only raise the public's emotional resonance, they also allow us to explore music's possibilities and 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 (CFO)

Thank you, Tony. Hello, everyone. Next, I'll discuss our results from financial perspective. In the second quarter of 2023, driven by significant growth in our music subscription and advertising business, our total revenues reached RMB 7.3 billion, up by 6% year-over-year. Revenues from online music services contributed 58% of total revenues, passing the revenue contribution from social entertainment service for the first time in our history, and marking a significant milestone for us. Our non-GAAP net profit was RMB 1.3 billion and RMB 1.6 billion, respectively. Non-GAAP net profit margin reached 21.7% this quarter. Music subscription revenues in Q2 reached RMB 2.9 billion, up by 37% year-over-year, and by 11% sequentially, with rapid expansion of online music paying users and a continued increase in monthly ARPU.

Specifically, number of online music paying users grew to 19.4 million, up by 20% year-over-year, representing net adds of five million users sequentially. Monthly ARPU has grown for five consecutive quarters and reached a record high of RMB 9.7 this quarter, up by 14% year-over-year and 5% sequentially. Our optimized user operations, more appealing member privileges, attractive music contents, and disciplined promotions have driven the growth and will continue to strengthen the foundation for sustainable growth in our music subscription business. 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 comparison in Q2 2022. The annual 618 e-commerce sales event 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 RMB 3 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 experience. 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, nonetheless, we believe these measures are necessary and are beneficial to our users, which will help lay down a healthier and 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 ARPU, 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 RMB 1.3 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 RMB 211 million, down by 30% year-over-year, as we have optimized our promotion strategies by reducing user acquisition spending, monitoring the ROI of each promotion channel, and being more focused 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 RMB 1 billion, down by 6% year-over-year. This decrease was primarily due to decrease in employee-related expenses as a result of improved headcount expenses.

Expenses related to our application for secondary listing last year also contributed to the year-over-year decrease. We continue to closely manage employee-related expenses by improving headcount, headcount expenses, and invest in research and development to further empower music-related content creation, enhance production expenses, and improve sound 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 RMB 1.3 billion. Non-IFRS net profit and non-IFRS net profit attributable to equity holders of the company were RMB 1.6 billion and RMB 1.1 billion, respectively. Diluted earnings per ADS was RMB 0.82, up 55% on a year-over-year basis. Non-IFRS diluted earnings per ADS was RMB 0.97, up 54% on a year-over-year basis.

As of June 30, 2023, our combined balance of cash, cash equivalents, and term deposits were RMB 30.5 billion, as compared with RMB 28.5 billion as of March 31, 2023. The increase was primarily due to strong cash flow generated from operations of RMB 2.1 billion for the second quarter of 2023. Such a combined balance was also impacted by the change in exchange rate of RMB to USD at different balance sheet dates. 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 keen focus on user experience and monetization, we will continue to invest in new products and services, include high-quality contents, differentiated premium packages with appealing privileges, and new technologies such as AIGC, through organic development and M&A, to solidify our foundation for long-term growth. This concludes our prepared remarks. With that, I'll turn the call back to Cussion.

Cussion Pang (Executive Chairman)

Thanks, Shelly. Before we enter the Q&A section, 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 advance TME's prosperous development. We really appreciate Tony's years of excellent work and invaluable contribution to the group. Thank you, Tony. Now we are ready for questions. Operator, please.

Operator (participant)

Hello, everyone. If you are dialing in by phone, please press five to ask a question, and then press six to unmute yourself. If you are accessing the call from the Tencent Meeting or Zoom Meeting application, please click the Raise Hand button at the bottom left. For the benefit of all participants on this call, please limit yourself to one question, and if you have additional questions, you can re-enter the queue. If you ask your questions in Chinese, please repeat them in English. Okay, our today's first question comes from Alex Yao from JPMorgan. Alex, your line is open. Please go ahead. Thank you.

Alex Yao (Analyst)

Thank you, management, for talking us through the fundamental development during the quarter. 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? I have a related follow-up question, i.e., if we take a multi-year 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 full quarters of rebasing period? Thank you.

Cussion Pang (Executive Chairman)

Okay, thanks, Alex, for the questions, and I'll take the first part regarding the revenue outlook, and maybe Tony can take the second part of the questions. This quarter, our online music services revenue contributions reached nearly 60%, representing a significant growth from only 30% five years ago. Looking at the revenue contribution of our subscription businesses, it has grown from only 30% five years ago to 40% this quarter. This progress are really demonstrating that, since we go IPO, 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 2023, our online music business is expected to maintain a robust growth, driven by both the paying user growth and ARPU 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 adjustment related to certain live streaming functions. Nonetheless, barring any major unexpected events, we anticipate that the impact level of this adjustment will stabilize by the end of Q3, and subsequently, monthly revenue in Q4 will become relatively stable on a month-to-month basis.

Therefore, we expect that the total revenue for this year will decline by low to mid-single digit percent year-over-year, but our full year profits and profit margins will see further improvements. 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 the 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. We believe that the adjustment made to our live streaming business will allow us to unlock the next level of development on a more solid footing.

Tony Yip (Chief Strategy Officer)

Thank you, Cussion. 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 lower level. However, barring any significant unexpected events, we currently do anticipate that impact level of these adjustments to stabilize by the end of Q3. Therefore, you know, we expect monthly revenue for social entertainment services to stabilize on a month-on-month basis in Q4. Yeah, I think that's the only thing I'll add.

Operator (participant)

Thank you, Alex. Our next question comes from Lei Zhang from Bank of America Merrill Lynch. Lei, your line is open. Please go ahead. Thank you.

Lei Zhang (Analyst)

Hi, management. Thanks for taking my question, and best wishes to Tony, on your new journey. If I may want to follow up on social entertainment set, can you give us some, you know, the rationale behind these significant adjustments? 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? Thank you.

Tony Yip (Chief Strategy Officer)

Yeah. I think the motivation behind these adjustments are to create a more music-centric live streaming atmosphere for our users. You know, and these adjustments include stricter compliance procedures, and, you know, also adjustments to certain live streaming functions. It enables us to better control potential risks that the platform may face in the future. Even though, you know, 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.

I think, you know, like, like I said, I think in terms of outlook for this, the social entertainment revenues, it effectively resets 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 (participant)

Okay. Thank you, Lei. Our next question comes from Alex Poon from Morgan Stanley. Alex, your line is open. Please go ahead. Thank you.

Alex Poon (Analyst)

Thank you, management, for taking my question. 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? My follow-up question is regarding our share buybacks and dividends, if any, consideration. Thank you.

Tony Yip (Chief Strategy Officer)

On the subscription side, you know, we continue to expect the subscription revenue to grow at a healthy trend, you know, driven by a number of factors. Frankly, I think many of these have been results of years and years of hard work.

I think, you know, kind of top down perspective, you know, we spend years of march market education, encouraging users to develop a music consumption mindset to support copyrighted music. You know, we have continued to refine our operational strategies, enrich user privileges such as sound quality and sound effects. As a result, you know, we are seeing a gradual shift towards increasing willingness to pay for music services, as well as for privileged product features.

On the ARPPU side, as we mentioned for several quarters now, you know, we will continue to follow our strategy towards optimizing our promotional discounts. You know, gradually reducing them, and to enhance the user's perception of the value that they paying. And for those users who are, you know, who have higher expectations for sound qualities and additional demand for use scenarios, we do have other premium product options at a higher price point. Right?

You know, besides Super VIP as well as other IoT memberships, you know, we also launched premium packages that are tailored to couples, for example. 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 going forward. Then on buyback, you know, obviously I think we have announced the buyback as you saw. You know, we haven't conducted a buyback to date, but we will be actively looking for opportunities to do so. You know, if the right opportunities present itself, especially in times of share price weakness.

Operator (participant)

Okay, thank you, Alex. Our next question comes from Lincoln Kong from Goldman Sachs. Lincoln, your line is open. Please go ahead. Thank you!

Lincoln Kong (Analyst)

Thank you management for taking my question, and all the best to Tony as well. I want to ask about your 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 the any AIGC tools or the large language model we are currently leverage on? How we think about the whole AIGC to empower our business? Thank you.

Speaker 12

对 ， 我 们 ， 就 是 始 终 还 是 认 为 说 ， 呃 ， 这 是 一 个 很 大 的 一 个 浪 潮 吧 ， 就 是 我 们 要 也 是 要 抓 住 这 个 机 会 。 呃 ， 但 是 我 们 确 实 也 ， 呃 ， 就 像 之 前 其 实 已 经 提 了 很 多 次 了 ， 我 们 在 大 模 型 的 这 个 基 础 研 究 上 ， 还 是 ， 呃 ， 我 们 主 要 还 是 在 应 用 上 面 来 去 做 很 多 的 努 力 吧 。 呃 ， 当 然 我 们 也 也 在 等 待 吧 ， 在 等 等 腾 讯 在 我 们 的 我 们 推 出 混 元 以 后 ， 我 们 能 跟 在 基 于 混 元 这 个 大 模 型 上 ， 我 们 能 去 做 更 多 的 上 面 的 上 层 应 用 。 呃 ， 当 然 我 们 也 其 实 可 以 发 现 ， 在 今 年 的 整 个 整 个 的 变 化 里 面 ， 其 实 应 用 还 是 一 个 最 为 主 要 的 一 个 ， 呃 ， 场 景 ， 就 是 一 个 还 是 需 要 大 家 再 持 续 去 摸 索 。 那 对 于 我 们 来 说 ， 呃 ， 在 内 容 内 容 部 分 呢 ， 我 们 还 是 刚 才 ， 呃 ， 之 前 也 提 到 ， 就 是 我 们 在 内 容 生 产 部 分 还 是 希 望 能 够 给 创 作 者 更 方 便 的 一 个 工 具 ， 所 以 我 们 也 通 过 也 发 布 了 奇 明 星 ， 在 奇 明 星 里 面 提 供 了 一 套 一 系 列 的 这 样 的 一 个 一 套 工 具 ， 包 括 AI 作 词 辅 助 ， 呃 ， 音 乐 分 离 、 智 能 曲 谱 ， 啊 ， 智 能 智 能 封 面 ， 这 些 都 是 去 能 够 去 帮 助 音 乐 人 去 提 升 这 个 效 率 。 但 是 ， 呃 ， 所 以 这 块 这 部 分 仍 然 还 是 在 处 于 一 个 辅 助 创 作 的 这 样 一 个 领 域 ， 那 到 底 是 否 在 后 面 会 出 现 ， 呃 ， 通 过 一 个 端 到 端 的 这 样 的 一 个 所 有 的 歌 曲 都 是 通 过 人 工 智 能 产 生 的 ， 这 个 我 们 还 在 保 持 观 察 。 当 然 我 们 现 在 也 确 实 在 开 发 一 些 功 能 ， 是 能 够 去 自 动 去 识 别 ， 是 在 系 统 后 台 能 够 识 别 这 首 歌 曲 是 由 人 工 创 作 ， 呃 ， 是 由 人 创 作 的 还 是 由 机 器 创 作 的 。 另 外 一 个 酷 狗 呢 ， 酷 狗 这 边 也 发 布 了 一 个 音 乐 ， 呃 ， 音 色 制 作 人 ， 那 它 可 以 通 过 基 本 生 成 很 快 的 一 个 ， 因 为 我 们 知 道 就 是 通 过 zero shot 和 few shot 能 够 很 低 样 本 的 去 生 成 用 户 的 声 音 库 ， 就 能 够 通 过 这 些 声 音 库 可 以 生 成 不 同 风 格 的 和 语 言 的 这 种 歌 曲 。 同 时 我 们 也 在 这 其 中 发 现 了 一 些 商 业 模 式 ， 就 是 用 户 可 以 去 花 一 部 分 钱 ， 去 省 花 ， 呃 ， 花 了 不 少 ， 呃 ， 不 多 的 费 用 ， 能 够 去 生 成 自 己 的 跟 自 己 相 相 应 的 风 格 的 歌 曲 ， 啊 ， 同 时 也 能 够 降 低 自 自 己 的 个 人 的 ， 然 后 同 时 来 进 行 传 播 吧 。 呃 ， 另 外 当 然 就 还 是 之 前 提 到 ， 就 是 在 生 成 式 AI 仍 然 还 能 够 去 缩 短 ， 缩 短 我 们 的 研 发 时 间 ， 这 也 是 ， 这 个 也 是 大 家 其 实 在 研 在 很 多 地 方 都 可 以 看 到 的 ， 比 如 在 在 Office 里 面 和 ， 呃 ，GitHub 里 面 去 ， 去 通 过 代 码 的 生 成 能 提 升 和 文 档 的 生 成 ， 来 提 升 一 个 工 作 效 率 。 那 么 在 用 户 互 动 体 验 方 面 ， 我 们 近 ， 这 ， 在 这 个 季 度 ， 我 们 重 点 其 实 做 了 ， 呃 ， 一 个 虚 拟 偶 像 的 一 个 聊 ， 就 是 小 琴 这 样 一 个 虚 拟 偶 像 ， 那 她 现 在 目 前 能 做 什 么 样 的 事 ， 一 个 ， 那 她 能 做 什 么 样 的 事 情 ？ 她 能 够 ， 呃 ， 首 先 能 够 陪 人 一 起 听 歌 ， 然 后 根 据 这 个 人 的 属 性 能 够 去 推 荐 不 同 的 歌 曲 ， 就 当 你 如 果 找 不 到 一 个 真 实 的 人 的 时 候 ， 你 可 以 通 过 可 以 去 跟 这 样 一 个 AI 的 一 个 ， 一 个 ， 一 个 机 器 人 吧 ， 可 以 认 为 虚 拟 人 ， 然 后 跟 他 去 ， 去 来 ， 呃 ， 他 可 以 给 你 推 荐 一 些 歌 曲 ， 让 你 们 来 一 起 来 听 ， 同 时 你 也 可 以 跟 他 去 聊 天 ， 然 后 他 会 告 诉 你 这 个 音 ， 这 个 作 品 的 评 价 ， 同 时 也 能 跟 你 去 聊 一 些 情 绪 上 的 事 。 从 我 们 事 实 发 现 ， 就 是 里 面 中 用 户 对 这 个 还 是 非 常 的 ......

呃 ， 买 单 呢 ， 就 它 里 面 会 发 现 很 多 ， 他 们 就 是 基 本 上 跟 小 琴 当 成 一 个 真 实 的 人 去 在 闲 聊 ， 呃 ， 甚 至 谈 一 些 感 情 和 一 些 ， 呃 ， 其 他 的 琐 事 吧 。 呃 ， 另 外 我 们 也 开 创 了 ， 就 是 在 小 琴 这 边 ， 我 们 对 音 乐 作 品 去 做 评 论 ， 就 是 她 可 以 在 很 多 音 乐 人 的 作 品 下 面 去 根 据 音 乐 内 容 去 做 AI 的 评 论 。 那 我 们 也 发 现 她 的 评 论 在 促 进 这 个 音 乐 人 本 身 创 造 歌 曲 ， 以 及 下 面 的 用 户 的 评 论 互 动 上 都 提 到 了 非 常 好 的 一 个 —— 都 提 升 了 很 好 的 留 存 率 。 那 么 在 直 播 场 景 下 ， 我 们 其 实 首 创 了 一 个 AI 送 礼 的 新 的 商 业 模 式 ， 就 是 当 你 - 你 去 送 礼 的 时 候 ， 你 可 以 —— 因 为 原 来 的 所 有 的 人 的 送 礼 都 是 统 一 ， 都 是 一 样 的 。 那 在 我 们 这 个 季 度 ， 我 们 做 了 一 个 AI 生 成 虚 ， 你 自 动 生 成 ， 生 成 了 一 个 虚 拟 礼 物 ， 就 是 你 ， 你 可 以 在 给 主 ， 在 给 主 播 送 礼 的 时 候 输 入 不 同 的 文 字 ， 然 后 用 跟 这 个 promote， 跟 这 个 提 示 词 ， 就 可 以 生 成 ， 呃 ， 各 种 属 于 你 自 己 的 这 样 的 一 个 礼 物 ， 然 后 去 送 给 主 播 ， 然 后 让 打 赏 成 为 一 个 个 性 化 。 就 所 有 人 其 实 可 以 生 - 生 成 完 全 属 于 自 己 个 人 的 虚 —— 自 己 只 要 去 创 作 不 同 的 提 示 词 ， promote 就 可 以 生 成 不 同 的 礼 物 了 。 啊 ， 而 且 这 里 面 其 实 最 关 键 的 是 因 为 我 们 做 了 大 量 的 推 理 的 优 化 ， 这 样 可 以 使 生 成 这 个 礼 物 的 时 间 大 大 缩 短 。 因 为 我 们 也 知 道 ， 其 实 在 生 成 式 AI 里 面 ， 其 实 最 核 心 的 一 个 部 分 是 生 成 的 速 度 ， 如 果 你 生 成 速 度 达 不 到 ， 你 的 成 本 和 你 的 体 验 其 实 都 是 大 打 折 扣 的 。 所 以 我 们 在 生 成 的 ， 在 推 理 速 度 上 也 做 了 很 大 的 优 化 。 所 以 另 外 我 们 在 也 在 探 索 一 个 我 们 比 较 寄 ， 希 望 有 AI 的 社 交 的 WeBan 伴 的 ， 一 个 叫 WeBan 伴 的 一 个 app， 那 正 在 ， 正 在 内 测 了 。 这 个 其 实 跟 美 国 的 Character AI 还 ， 呃 ， 有 点 类 似 吧 ， 就 它 其 实 还 是 可 以 去 选 择 不 同 的 一 个 对 象 ， 你 可 以 选 择 不 同 的 ， 不 同 的 一 个 IP 的 一 个 ， 你 可 以 选 择 一 个 ， 一 个 比 较 男 孩 ， 或 者 你 可 以 选 择 一 个 游 戏 里 面 的 一 个 人 物 ， 然 后 跟 他 去 做 对 话 ， 然 后 同 一 个 去 聊 天 。 同 时 ， 同 时 这 个 机 器 人 可 以 发 语 音 ， 它 还 可 以 发 朋 友 圈 ， 可 以 发 图 片 ， 呃 ， 可 以 发 视 频 ， 让 它 有 一 个 非 常 逼 真 的 这 样 的 一 个 沟 通 的 环 境 。 这 是 我 们 目 前 正 在 开 启 内 测 的 一 个 ， 一 个 ， 也 是 ， 也 是 有 一 些 ， 呃 ， 希 望 能 在 这 里 面 有 一 个 更 ， 更 好 的 一 个 尝 试 吧 。

Tony Yip (Chief Strategy Officer)

Okay, I'll provide a brief translation. You know, we'll continue to ride the wave of innovation that are brought to us with AIGC. You know, while there has been a lot of focus on large models, our own focus are more on the application layer, which are primarily twofold: on either the content side or on user, user interaction side. On the content side, you know, we will, you know, work on providing productivity tools to assist musicians to become more efficient with the music creation. You know, whether or not we will see one day a fully automated end-to-end solution remains to be seen, but that's something, you know, we, you know, we would, we would continue to monitor.

We are working on and are starting to provide synthetic voice creation, you know, which where users can pay to use AI to create their own voice, to sing and to do other things. Finally, we are using AI capabilities to dramatically shorten our R&D time. On the user interaction side, with Xiaoqin, which we mentioned previously, it's a companion that guide your music journey. She can re-recommend songs to you, she can chat with you and tell you her views on particular songs. She can also comment on individual songs.

On the live streaming front, you know, we are able to use AI to instantaneously create a customized, virtual gift, based on the words 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. Then finally, we are working on, a new product called WeBan, which are similar to, a feature where users can chat with various AI characters.

Operator (participant)

Okay, thank you. Our next question comes from Alicia Yap, from Citigroup. Alicia, your line is open. Please go ahead. Thank you.

Alicia Yap (Analyst)

Hi, good evening. Can you hear me okay?

Tony Yip (Chief Strategy Officer)

Yes. Yes.

Alicia Yap (Analyst)

Okay, right. Good evening, management. Thanks for taking my questions, and also all the best to Tony. 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? Thank you.

Shirley Hu (CFO)

Okay. Let me first talk about the gross margin. Gross margin is 34.3% in Q2, increased by 44% year-over-year, due to some factors as follows. First, online music service have shown strong growth momentum, with high-quality growth to musical subscription revenues, driven by the continued uptick in the online music paying user base and monthly ARPU. Second, the robust growth of advertising revenues. Third, our self-owned content gradually ramp up. That has a positive impact on our gross margin, and it will continue to be a favorable factor for our gross margin. Fourth, we optimize the content cost model of RS and increased our requirement of content cost this year.

The fifth, license cost of long-form audio decreased at a year-over-year basis. The sixth, to optimize the technology and operation strategy related to bandwidth and storage capability, and improve the utilization of our service and equipment. Our gross margin has improved for five consecutive quarters. Looking forward to Q3, we expect the subscription revenue and the advertisement revenue will continue to be strong growth. On the cost side, we expect our in-house made content will have 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 significant in Q3, we expect our gross margin will be increased sequentially, and the gross margin in 2023 will be higher than that in 2022. Now we move to our OpEx.

We continue focused on improving our efficiency of OpEx in 2023. Over the past quarters, our ROI-oriented marketing strategy has proven successful in saving costs and enhance 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 internal and external resources. 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 the headcount efficiency, pay more attention to improve the profitability of business and products, adjust headcount according to profitability of business. Meanwhile, we are continuously monitoring new opportunities within the content ecosystem and cutting-edge technologies, and invest in such areas.

Looking forward to Q3, 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 base in the second half year of 2023.

Operator (participant)

Thank you. Our next question comes from Thomas Chong from Jefferies. Thomas, your line is open. Please go ahead. Thank you.

Thomas Chong (Analyst)

Hi, good evening. 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? Thank you.

Cussion Pang (Executive Chairman)

Thank you, Thomas, for the questions. As the 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 musics. We also assisting them in promoting their works on our platform. We are so delighted to witness that the continuous increase in the proportion of original content on our platform nowadays, after years of investment and cultivation, and is increasingly good. 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 offline performance opportunities and also exposure, and launches film programs to encourage the innovative content production. It also provides various commercial opportunities as well, including the royalty, online giftings, digital album sales, and overseas distribution. All these are all solid means of support for the artists. Secondly, our all-in-one music production and promotion platform, Venus, is designed for producing and transacting the, the demo and also the cover works. It has attracted numerous content creators and music labels, so letting continue promoting resources consolidation efficiency. In addition, I think we also collaborate with the 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 Honor of Kings and Peacekeeper Elite. In the animation and film, we have also partnership with the popular IP, like L.O.R.D, the Land of Warriors, and the Spider-Man. All of these are really exciting content development project that we have online right now. In terms of the content production promotions, we have a wealth of internal and external resources. Internally, we have the three major music platforms, and also externally, we can work with the Tencent ecosystem for our corporate collaboration with the Weixin, and we can prompt on the Weixin official account and Weixin video account, to which a massive user base as well. Last but not least, we also helping our content provider to-

Tony Yip (Chief Strategy Officer)

-do the music distribution to overseas market as well through our TME Music Cloud service, which I think is very meaningful to help promoting Chinese original music in the international market as well.

Operator (participant)

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

Xueqing Zhang (Analyst)

Thanks management for taking my question, and also best wishes to Tony. Just a quick question on IoT. Do you have any color on in-car service progress, such as monetization and the revenue contribution? Thank you.

Speaker 12

对 ， 我 们 在 IoT 这 块 的 布 局 ， 主 要 就 是 在 呃 ， 车 载 和 智 能 音 箱 和 智 能 电 视 吧 。 现 在 我 们 其 实 重 点 还 发 现 ， 车 载 反 正 肯 定 一 定 是 大 家 最 主 要 ， 主 要 的 发 展 方 向 ， 尤 其 智 能 汽 车 ， 我 们 最 近 也 知 道 ， 这 比 亚 迪 刚 刚 宣 布 了 自 己 的 第 五 百 ， 五 百 万 辆 车 下 线 ， 这 意 味 ...

呃 ， 上 ， 就 下 ， 基 本 上 就 意 味 着 ， 其 实 智 能 汽 车 在 未 来 的 发 展 ， 包 括 在 全 球 都 会 有 非 常 大 的 一 个 市 场 。 那 我 们 基 本 上 也 在 国 内 ， 包 括 国 内 ， 包 括 在 海 外 ， 我 们 都 在 去 积 极 地 拓 展 ， 呃 ， 包 括 说 JOOX 在 海 外 的 一 些 跟 车 机 的 一 些 合 作 的 机 会 。 那 当 然 你 可 以 看 到 ， 其 实 越 来 越 多 的 汽 车 厂 商 也 在 加 强 在 车 内 生 态 的 一 些 布 局 了 ， 其 中 就 很 明 显 就 是 ， 呃 ， 音 频 一 定 是 他 们 最 主 要 的 一 环 。 那 基 本 上 就 是 说 很 多 人 我 们 可 以 在 里 面 ， 包 括 我 们 最 近 的 一 些 我 们 的 在 全 景 声 上 ， 我 们 在 跟 杜 比 的 合 作 上 ， 呃 ， 应 该 包 括 我 们 在 无 损 音 质 上 ， 都 会 ， 呃 ， 在 音 质 音 效 的 这 么 长 久 的 一 个 布 局 ， 相 信 我 们 自 己 在 车 载 领 域 中 ， 实 际 上 还 一 直 有 比 较 领 先 的 地 位 。 好 ， 所 以 我 们 也 可 以 看 到 ， 就 是 说 我 们 跟 很 多 车 企 是 有 非 常 深 入 的 合 作 的 ， 啊 ， 包 括 像 上 汽 大 众 啊 ， 一 汽 大 众 ， 呃 ， 甚 至 奔 驰 、 特 斯 拉 ， 基 本 上 我 们 都 会 能 够 去 提 ， 提 供 非 常 ， 呃 ， 专 业 的 方 案 ， 给 车 ， 给 这 些 车 商 去 提 供 沉 浸 式 的 体 验 。 同 时 我 们 今 年 也 刚 刚 ， 就 刚 刚 上 ， 在 上 个 季 度 我 们 发 布 了 QQ 音 乐 的 车 载 二 点 零 版 本 ， 呃 ， 如 果 你 们 去 看 的 话 ， 可 以 获 得 了 非 常 好 的 用 户 的 反 馈 ， 呃 ， 在 尤 其 在 用 户 体 验 方 面 。 那 么 在 IoT 上 面 ， 我 们 保 持 了 比 较 好 的 ， 就 是 从 趋 势 上 来 看 ， 无 论 是 用 户 规 模 还 是 收 入 上 ， 都 会 ， 我 们 都 会 看 到 有 比 较 好 的 一 个 增 长 。 呃 ， 尤 其 是 Kuwo 车 载 和 QQ 音 乐 车 载 都 会 拥 有 比 较 好 的 ， 呃 ， 市 场 占 有 率 。 同 时 也 可 以 ， 呃 ， 之 前 也 提 到 ， 就 是 在 五 一 期 间 和 暑 假 期 间 ， 由 于 旅 行 的 线 下 旅 行 市 场 的 极 大 繁 荣 ， 呃 ， 使 得 在 车 载 市 场 上 的 用 户 活 跃 度 跟 粘 性 都 有 非 常 明 显 的 ， 呃 ， 增 加 。 所 以 我 们 也 希 望 ， 我 们 相 信 ， 就 是 从 长 远 来 看 ， 呃 ， 在 车 载 ， 车 载 上 面 的 额 外 的 这 些 用 户 规 模 和 ， 呃 ， 市 场 化 的 机 会 ， 也 能 够 驱 动 我 们 整 个 ， 呃 ， 公 司 的 用 户 规 模 跟 收 入 的 增 长 。

Tony Yip (Chief Strategy Officer)

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, via JOOX. You know, music, as you know, will be a prime entertainment use case, within smart cars. Through our premium sound effects, such as our partnerships with Dolby, you know, we stand well-positioned to benefit. We also have deeper 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 user as well as revenues are seeing rapid growth.

You know, as an example, during the May holiday, you know, where we've seen a significant increase in holiday and time spent during cars. We have seen a significant uptake in music consumption and spending. As a result, over the long term, we are very optimistic that IoT, you know, specifically car services, will provide us with a great opportunity for subscription and revenue going forward.

Operator (participant)

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

Tony Yip (Chief Strategy Officer)

Well, this closes 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. Thank you, everyone. Thank you, everyone.

Speaker 12

Thank you, everyone. Thank you. Take care.