Tencent Music Entertainment Group - Q4 2022

Transcript

Tony Yip (Chief Strategy Officer)

Good evening and good morning. Welcome to Tencent Music Entertainment Group's fourth quarter and full year 2022 earnings webinar. TME announced quarterly financial results today after market close. An 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. Mr. Ross Liang, our CEO, and I, Tony Yip, a CSO, will offer additional thoughts on our product strategies, operations, and business developments. Ms. 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 statement 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 the management's presentation, there will be a Q&A session. For participants who have dialed in by phone, please press five to ask a question. If you are accessing the call from Tencent Meeting or VooV Meeting application, please click the Raise Hand button at the bottom left. Please be advised that today's webinar is being recorded. With that, I'm pleased to turn the call over to Cussion Pang, Executive Chairman of TME. Cussion Pang.

Cussion Pang (Executive Chairman)

Thank you, Tony. Hello, everyone, and thank you for joining our call today. Looking back on 2022, firm execution of our dual engine content and platform strategy fueled solid progress in a fast-changing macro environment. With a keen focus on high-quality growth and product innovation, as well as our highly effective cost optimization measures, we led the industry in the rebound of bottom line growth and delivered steady growth in online music subscriptions throughout the year. Our diversified suite of monetization tools expanded and make progress during the year, such as ad-supported mode, long-form audio, as well as audio live streaming, and our international expansion, among many more. With our confidence in the long-term prospects of the company, we had completed the $1 billion share buyback program approved by the board in 2021.

Looking ahead into 2023, as we are repositioning ourselves to better capture future growth areas, we currently expect our quarterly revenues from online music services will exceed those from social entertainment services at some point within this year. Meanwhile, with our relentless focus on executing our growth strategies and operating efficiencies, we are confident to achieve year-over-year growth in total revenues and profitability, as well as continuous improvement in user quality in 2023 while fueling the thriving music industry. Next, I would like to talk about remarkable achievements we have made in many aspects of our businesses to build upon our insistence on excellencies and innovation. We are building extensive collaboration with top artists, labels, and industry partners, both at home and abroad, to bring our users and artists most compelling content and experiences. One integral part of our strategy in 2022 was to continue improving TME's content ecosystem.

We have recently reached an agreement with Jay Chou, 젤웨이에르, to extend our close strategic partnership, and we will continue to provide our users with the high-quality music created by Jay Chou, accentuated by the extraordinary experience on our platform. In the fourth quarter, we deepened our strategic cooperation with leading records such as B Music, 三 星 音 乐, providing users with songs from Mayday, 五 月 天, and other renowned singers. Our flourishing library in various music verticals also reinforced our reputation as a go-to destination for music lovers. Importantly, we began extensively teaming up with Billboard, the industry bellwether. In addition to co-produce a playlist, we jointly released the 2022 Annual Music Report, which attracted participation from a record high number of unique visitors.

Most recently, we announced the integration of TME UNI Chart, 腾 讯 音 乐 有 力 榜 , on Billboard as its only music chart for mainland China, introducing Chinese music to a global audience. Second, as we drove to increase the breadth and depth diversity of our music library, our ability to empower original content production has significantly improved with new tools launched. We have been investing in intelligent tools to support music-related content production with technology and has delivered promising results. With virtualization setting the trend, one strategic move in 2022 was to build a lineup of virtual performers. In the Q4, we unveiled our first hyper-real virtual pop idol, LUCY, 吕 小 希 , who is also the whole music presenters for today's call.

With a record-grade automatically generated vocal prints developed by TME LYRA LAB's LyraSinger Engine, 听 琴 实 验 室 的 琴 语 引 擎, LUCY, as a highly productive singer, has created three chart-dominating original songs across different styles within just one month of her debut and has already received partnership interest for fashion shots or joint performances from a broad array of global brands, including ELLE, Coca-Cola, and KFC. At the forefront for cutting-edge virtual idol field, our virtual performers also include Xiaoqin, Shanbao, and Anko, who we brought to life with original content, unique voices, dance moves, and more. Musicians are also increasingly flourishing on our Tencent Music platforms, driving content prosperity both on our platform and in the industry. By the end of fourth quarter, we have empowered our indie musicians to create more than 2.3 million musical works.

Meanwhile, we consistently pay close attention to music ecosystem development. In the fourth quarter, we launched more smart features and tools for indie musicians to accelerate song composition and release and foster deeper interactions with their fans. For example, in December, we unveiled a record release feature, 原 创 专 辑 将 开 通 赞 赏 发 行 模 式 , which allows indie musicians to upload their original albums and earn revenue from listeners who want to show extra gratitudes in addition to album sales. What's more, the tech tools we launched during the quarter enable our musicians to generate lyrics and album covers automatically, as well as assist in singing enhancement and song evaluation, all of which help form a modularized and automated music production process.

We are proud that our end-to-end services have been instrumental in realizing a year of harvest for the creation of close to 1,000 original blockbusters, leading to streams exceeding 100 million each in 2022. In the fourth quarter, the hit song, Grant Me, 赐 我 , dominated trending lists on our platform and took the market by storm, ranking in nearly half a billion streams. Another hit was Turn into Fireworks and Fall for You, 化 作 烟 火 、 为 你 坠 落 , which has been extensively used as background music and generated over 5 billion social media discussions. Meanwhile, we deepened our collaboration with the Tencent ecosystem and launched a total of 111 songs in the gaming and animation category in 2022. A number of our co-produced songs have garnered awards this year.

Notably, Fairytale Love, 仙 境 恋 歌 , made for Peacekeeper Elite, 和 平 精 英 , was among the finalists for the Best Original Song in the Mobile Video Game category of the 13th Hollywood Music in Media Awards, 第 十 三 届 好 莱 坞 传 媒 音 乐 奖 . Behind this high-quality musical work, more up-and-coming artists are finding opportunities and stages to shine and realize their music dreams on the back of TME's all-around promotional resources. One example in the fourth quarter was a strategic musician partner we cultivate, Krystal Chen, 陈 卓 璇 . We invited well-known producers to launch her first EP, from which the song, Skylights, 天 光 , topped the QQ Music's Best New Release Music chart, helping her build her profile as a high-quality singer.

Another standout find was the campus musician, Pan Yunqi, who was featured on the cover of Billboard's December issue with her first single, Letters Alive, 见 字 如 面, and also came in the third place in 2022 Sing China, 恶 人 恶 人 中 国 好 声 音, with our coaching. We collaborated with Coca-Cola to create a large-scale New Year's music event and promoted emerging musicians such as Pan Yunqi to the world stage through Billboard's global network. Many newly joined musicians have grown quickly into rising stars with our support, representing just a few of our success stories among a strong pipeline of emerging talents we are grooming to fuel the thriving music industry. That concludes my review of our growing content strategy.

Now I would like to turn the call over to Ross, who will share more about our platform updates. Ross, please go ahead.

Ross Liang (CEO)

Thank you, Cussion. Hello, everyone. With our refined mission in 2022 to create endless possibilities with music and technology, 2022 was a year of our continued exploration for TME. We stable up creative efforts to satisfy our users' nuanced and diverse music tastes and to provide all-around musical companionship to our users through each of our four entertainment pillars: listen, watch, sing, and play. We have been deploying and developing breakthrough AIGC tools to further import music-related content creation and enhance production efficiency. In addition to the Lyra singing engine, which we used to develop our virtual idols, such as Kasha mentioned, we rolled out the Muse Engine in the fourth quarter, which enables automatic large-scale music posters production based on melody and the lyrics.

We have also expanded use cases for our patented technology, Ling Yin Engine, to launch several popular audiobooks read by the synthetic voice of Yang Chaoyue, including The Grave Robbers' Chronicles, 盗 墓 笔 记. What's more, ahead of the new year, receivers of QQ Music's newly launched VR greeting card can walk into the gift generated automatically, and they receive blessings as avatars in an exquisite virtual space. In the future, we will continue to explore the application of large language models in the field of pictures, texts, video, and other content, as well as music recommendation and search to meet the massive demand for music-related content.

One of the biggest advancements in the year was to holistically improve our sound quality and sound effects, and bring users a clear and a more vivid listening experience, which also contributes to the growth of music subscription, as well as we are adding this compelling privilege to our memberships. For example, nearly half of our QQ Music music tracks now support superior quality or above, and our Hi-Res standard has also been upgraded to Hi-Res Lossless, Hi-Res 无 损 音 质, which parallels the top-tier studio qualities for a maximum resolution of 100 and 92 kHz, 24 bit.

We continue to optimize our proprietary technology for the premium sound series, launching Premium Master Tape, 真 品 母 带 , Premium Surround Sound, 真 品 全 景 , 全 景 声 , and Premium Sound Quality 2.0, 真 品 音 质 二 点 零 , to enhance sound clarify and expressiveness. We also extended the application of these premium sound quality features to TME live's online concert, such as Ryuichi Sakamoto's concert, as we concentrated on building a new benchmark in sound quality for the domestic streaming industry. More users are opting for songs with high sound quality. On QQ Music, their number exceeded 5 million on a daily basis, totaling nearly 100 million daily streams. We also launched and enhanced a number of features to allow users to flexibly customize their listening experience.

Kugou Music and QQ Music all unveiled a pitch and a tempo alteration feature, 变 调 变 速 , with which users can remix their favorite songs. Our algorithms upgraded also contributed to a more personalized listening experience, leading to sustained healthy year-over-year growth in QQ Music and the Kugou Music's recommendations, streaming volumes, and the time spent per user in the fourth quarter. Specifically, QQ Music's recommendation inspired more listening behavior than search, which continues increase in the percentage of streams coming from our recommendation. Another focus in 2022 was to enrich users' virtual experiences on our platforms, particularly through comprehensive collaboration with Weixin video accounts in the Tencent ecosystem. Through TME live, our performance brand which hosted 63 online and offline events throughout 2022.

We held hands with Weixin video accounts to innovate interactive formats and build new avenues to distribute music and video content. For instance, at Hacken Lee, 李 克 勤 's concert, nearly 20,000 users cast their votes on either our platform or Weixin video accounts to select the final encore. We also joined, attracted over 23,000 paying viewers to watch the eminent Japanese pianist Ryuichi Sakamoto, 坂 本 龙 一 's solo concert, which is the highest number to date among TME live's musical instrument performance. We further applied our song recognition feature to automatically identify the background music of videos from Weixin video accounts, and direct users to QQ Music to listen, set as their Weixin ringtone, or use in their own videos.

What's more, by the end of 2022, over 60,000 indie musicians on our Tencent Musician Platform have used the one-click release feature to publish their original songs on WeChat video accounts. Beyond professional music content, during the fourth quarter, we also promoted user engagement by allowing our recent users to share music videos of their own singing on WeChat video accounts. The hit song on WeChat video accounts, Good Morning, 轮 回 , 早 安 轮 回 , racked up nearly 100 million music streams on TME's platforms in the fourth quarter. A stronger testament to the vibrancy of our joint built music ecosystem with virtual elements. The singing features have also been upgraded to create more enjoyable experiences for our karaoke users.

In the fourth quarter, we rolled out several real-time features, namely the one-player mode Singing Master, 演 唱 大 师 , two-player model Karaoke King 2.0, K 歌 王 者 2.0, and the multi-player mode Mic ROM, 全 民 抢 , 抢 麦 , to enthrall users with the excitement of simultaneous singing and competition. On top of these new entertainment choices, during the fourth quarter, we also continued to engage WeChat users with the singing effect updates, such as the vocal enhancement, 人 声 增 强 feature for WeChat VIP users to create a studio-quality acoustics in our immersive singing environment. Music lovers, particularly the young ones, are getting attracted by our music-based virtual use cases.

At TME Land, our immersive virtual singing park, 8 million users in their avatars joined the Coca-Cola and the KFC's virtual parties and celebrate a super New Year alongside artists during the fourth quarter. We also released We Are Listening Together, We Are 一 起 听 相 声 , on TME Land, which brings users' avatars together to listen to content in virtual scenarios such as camping, rooftop star charts, and a New Year celebration. Lastly, to incubate a vibrant young and trendy culture community, we upgraded Kugou Concept, Kugou 概 念 版 , and the Bodian Music, Bodian 音 乐 , two of our music products designed for Gen Z users. During the fourth quarter, these updates include more real-time interactive features to help the young generation identify people with shared music tastes and encourage them to actively create, share, and socialize.

Thanks to the Gen Z warm receptions and the adoption of their diverse functions, these two apps both tripled their MAUs year-over-year. With that, I'd like to give the floor to Tony to reveal our business operations. Tony, please go ahead.

Tony Yip (Chief Strategy Officer)

Thank you, Ross. Hello, everyone. During the fourth quarter, the surge in COVID cases and churn of our casual users amid competition led to the year-over-year decline in online music mobile MAUs, along with cost optimization measures aimed at boosting monetization efficiency as a platform of scale. Meanwhile, we continue to strengthen our monetization capabilities with improved operating efficiency and have achieved high quality growth in both subscription and non-subscription revenue during the fourth quarter. Most excitingly, our subscription revenue de-delivered healthy growth year-over-year and quarter-over-quarter. Reflecting our balanced approach, online music paying users, a high quality user cohort, maintained a strong growth trend, and ARPPU also continued to improve sequentially for the third consecutive quarter and increased year-over-year.

The strong paying user and ARPPU momentum was driven by our improved operating strategy, leading to optimized content quality, more attractive member privileges, broadened sales channels, and more effective promotions. Subscribers to our Super VIP membership, 超 级 会 员 , continued to grow during the fourth quarter as we expanded our offerings to provide premium sound quality and Premium Master Tape and added a wealth of privileges such as long form audio, digital album, and karaoke to the membership package. On the non-subscription side, its revenue also improved year-over-year and quarter-over-quarter during the fourth quarter. Revenues from our advertising business continued to recover quarter-over-quarter. Specifically, ad-supported mode delivered strong performance during the quarter with sequential growth in its revenues.

Through our music with brands partnership, leading advertisers, including Wuliangye, Coca-Cola, KFC, and JD.com, embraced TME live and TME Land as innovative channels for musical format advertising in the fourth quarter, particularly given their appeal to young users. On the merchandising side, we worked with a wide range of A-list artists, including Lu Han, Lin Junjie, Wang Jiaer, Wang Yibo, Wang Yuan, Xue Zhiqian, Zhang Yixing this quarter to release their physical albums, digital albums, vinyl records, or customized artist merchandise with headstart benefits. Moreover, during the fourth quarter, we launched Artist Collection Cards, a new series of photo cards as collectibles in Puta Mall. We commenced the rollout with Kiku's card, which became highly sought after among young users, demonstrating our end-to-end content release advantage, spanning headstart benefits, artist-related products, and multi-channel promotion.

Moreover, we have strengthened our long-form audio content offerings with more audiobooks based on novel IPs and self-produced paid children's literature. Subscribers doubled year-over-year to surpass 10 million during the fourth quarter, driving solid year-over-year growth of revenues from long-form audio subscription. Our IoT service MAUs achieved double-digit growth year-over-year, thanks to our expanded model coverage, as well as a diversified content library with Dolby Atmos sound library and TME live content added respectively on selective electric vehicle and smart TV terminals. Moving on to our social entertainment services. During the fourth quarter, as a result of macro headwinds, increased competition from other platforms, and the surge in COVID cases, social entertainment services MAUs and paying users declined year-over-year. Against this backdrop, we will focus on product innovation and content differentiation while exploring fresh ways to fulfill users' social entertainment needs.

For WeSing, its multi-person singing room in both video and audio settings have continued to enrich real-time interaction scenarios on the platform, resulting in increased penetration rate and user time spent in these rooms. We are planning to roll out the feature to our other platforms in the future. Meanwhile, we took the operation experience from our singing and social products and our proven monetization models to the international market, expanding our presence through both organic growth and M&A. Revenues from our overseas business continued to increase year-over-year in the fourth quarter. For live streaming services, though macro environment continued to weigh on our revenues from traditional video live streaming, we focus on providing differentiated content and entertainment experiences to explore new value generators. Specifically, we are fostering a tighter connection between audio live streaming and our music platforms.

Following the successful expansion into live streaming by QQ Music, Kugou Music has also started to build up its audio live streaming service, which has a huge growth potential given its massive music user base. Leveraging our expertise in cultivating rising talents, we are creating more room for our indie musicians to grow into promising live streaming performers. For instance, in the fourth quarter, our self-produced hit songs like Puppetry, 木 偶 戏 , and Echo, 回 音 , helped their singers grow the number of fans substantially, thereby increasing both copyright revenue and live streaming income. Another example is our musician Li Wai. His original song, Worthless Relationship, 年 假 关 系 , has attracted high streaming volume and landed a spot on many of our music charts.

As we are building a bridge between performers and their fan bases, revenues from audio live streamings increased by double digits year-over-year, with solid growth in paying users and ARPPU year-over-year. Last but not least, during 2022, we continued to fulfill our social responsibilities with an innovative model to translate music's emotional expression and influence into social practices. The Spirit of Chinese Song, 中 国 韵 , our core cultural project, is now in its fourth year. In the fourth quarter, it launched an initiative for the Guangxi music style and partnered with singers Hu Xia and Liu Yuxin to promote Chinese traditional culture through the power of digital music.

In December 2022, many of the musical works from The Spirit of Chinese Song 2020, a public welfare album we released previously, officially entered the first digital collection of the National Archives of Publications and Culture, supporting the preservation and inheritance of Chinese culture. In conclusion, we exited 2022 with solid performance across our business, where we made significant advancements in content and platform upgrades, refined user experience, pushed forward with monetization models, and optimized costs, all together laying a solid foundation to fuel growth in revenues and profitability into 2023. As we move forward, we will remain committed to creating endless possibilities with music and technology to blaze a new trail in 2023 and in the years to come, while contributing to better fulfilling our responsibilities as a key music industry player.

With that, I would like to turn the call over to Shirley, our CFO, for a closer review of our financials.

Shirley Hu (CFO)

Thank you, Tony. Hello, everyone. I'll discuss our results from financial perspective. The fourth quarter of 2022 marked another quarter to evidence our firm commitment to cost control and operating efficiency improvement with continuous growth in IFRS and non-IFRS profit for the fourth consecutive quarter. In Q4, IFRS net profit was RMB 1.2 billion. Non-IFRS net profit was RMB 1.5 billion, up by 71% year-over-year and by 6% sequentially. Total revenues were RMB 3.4 billion, up by 0.8% sequentially. In Q4 2022, music subscription revenues grew to RMB 2.4 billion, up by 21% year-over-year and by 5% sequentially. Online music paying users grew to 88.5 million, up by 16% year-over-year, representing a 3.2 million net adds sequentially.

MAU up in Q4 was RMB 8.9, up by RMB 0.1 sequentially and by RMB 0.4 from Q4 2021. The strong paying user and ARPPU growth were driven by more attractive member privileges, such as improved sound quality, broadened sales channels, more effective promotions, optimized content quality, and high-quality services. This was also resulted from our ongoing efforts to cultivate users' willingness to pay for music and improvement in operating efficiencies. Revenues from advertising continued to recover and grew sequentially as markets started to recover and we launched new monetization models. To give our users more options, we launched AD-supported model and provided more inventory, which contributed to our revenue growth. With increased interest in innovation advertising channels, TME live and TME Land became popular and have attracted many leading advertisers for music format advertising. We remain confident about the long-term growth potentials in advertising business.

Social entertainment services and other revenues were RMB 3.9 billion, down by 18% year-over-year due to the evolving macro headwinds, competitions from other platforms, and surge in COVID-19 cases in the fourth quarter of 2022. To adapt to the changing environment and to stabilize revenue scale, we continue to differentiate our content offerings by enrich our visual interactive product offerings and cross-platform collaboration. Gross margin in Q4 was 33%, up by 4.2% year-over-year and by 0.4% sequentially. The increase was primarily due to improvement of monthly ARPPU for music subscription, growth of paying users, lower revenue sharing fees for live streaming services, and improved operating cost efficiencies. Now moving on to operating expenses.

Total operating expenses from Q4 were RMB 1.4 billion or 18.3% of total revenues, down by 5.6% from 23.9% of total revenues in the same period last year. Selling and marketing expenses were RMB 266 million, down by 65% year-over-year. This is our fourth quarter with more than 50% cut in selling and marketing expenses on a year-over-year basis. Although the reduced spending on user acquisition had impacted our MAUs, our core music subscription services continued its rapid and health growth trajectory. We continued to closely monitor the ROI of each promotion channel by utilizing external promotion channels and leverage of internal traffic to attract users and promote our brands. General and administrative expenses were RMB 1.1 billion, up by 26% year-over-year.

The increase was mainly due to increased investment in research and development areas such as international footprint, on-film audio, AD-supported model, etc. Our effective tax rate for Q4 was 12.2% compared to 11.5% in the same period of 2021. The increase in effective tax rate was mainly because some of our entities are entitled to different tax benefits in 2021 and 2022. For Q4, our net profit and net profit attributable to equity holders of the company were RMB 1.2 billion. Non-IFRS net profit and Non-IFRS net profit attributable to company reached a record high to RMB 1.5 billion and RMB 1.4 billion respectively. Non-IFRS net profit margin was 20.1%. Our basic and dilute earnings per ADS continued to grow in the fourth quarter of 2022.

Basic and diluted earnings per ADS were RMB 0.73 and RMB 0.72 respectively, up 121% and 125% on a year-over-year basis. Non-IFRS basic and diluted earnings per ADS were RMB 0.92 and RMB 0.91 respectively, up 80% and 82% on a year-over-year basis. Such results demonstrate our initial success on operating efficiency improvement as well as the impact from share repurchase program. As of December 31, 2022, our combined balances of cash equivalents, term deposits, and short-term investments were RMB 27.4 billion as compared with RMB 25.4 billion as of September 30, 2022. The increase was due to our health operating cash flow of RMB 2.5 billion for the fourth quarter of 2022.

Such combined balance was also affected by the change in exchange rate of RMB to USD at different balance sheet dates. Next, I'll briefly discuss our performance for full year 2022. Total revenues were RMB 28.3 billion, down 9% year-over-year. Non-IFRS net profit was RMB 3.8 billion. Non-IFRS net profit was RMB 4.9 billion, up by 13% year-over-year. Revenues from online music services were RMB 12.5 billion, up by 9% year-over-year, to which music subscription revenue was the largest contributor. Our music subscription business grew rapidly throughout the year with annual revenues of RMB 8.7 billion and a 19% annual growth rate. Revenues from social entertainment services declined by 20% year-over-year due to the changing macro headwinds, increased competition, and impact related to COVID-19.

Gross margin in 2022 was 31%, up by 0.9% year-over-year. The increase was primarily due to our effective control of content costs, including revenue sharing fees for live streaming services and improved operating cost efficiencies. Total operating expenses for 2022 were RMB 5.6 billion, down by 70% year-over-year. Particularly, selling and marketing expenses in 2022 decreased by 57% from 2021 as we reduced inefficient user acquisition costs and promotion activities during the year. Net profit and net profit attributable to equity holders of the company was RMB 3.8 billion and RMB 3.7 billion respectively. Non-IFRS net profit and Non-IFRS net profit attributable to equity holders of the company was RMB 4.9 billion and RMB 4.7 billion respectively.

I'll close with some comments on outlook for 2023. Build upon the success of effective cost and expense controls and operational efficiency improvement in 2022. We will focus on monetization expansion and revenue growth in 2023 while keeping cost and efficiency management. Our core online music services, particularly music subscription, will continue to be our key growth driver. Paying user and monthly ARPPU are expected to continue to grow. We'll continue to expand the suite of monetization tools, such as ad-supported model, physical albums, customized artist merchandise, Super VIP memberships, etcetera, and expect them to become important revenue contributors in 2023. For social entertainment services, with challenges from competitions and changing macro headwinds, we expect to place pressures in keeping revenue still and will continue to invest in audio live stream and extend our international footprint for long-term growth.

Furthermore, we will keep investing in high-quality contents and original content productions as well as new products and technologies such as AIGC. We are confident about the long-term health growth of our company and the overall music industry and remain focused on providing high-quality investment returns for our shareholders. This concludes our prepared remarks. Operator, we are ready to open the call for questions.

Operator (participant)

Hello, everyone. If you are dialing by phone, please press five to ask a question and then press 6 to unmute yourself. If you're accessing the call from the Tencent Meeting or Webex meeting application, please click the Raise Hand button at the bottom left. For the benefits of all participants on today's call, please limit yourself to only 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. Today's first question comes from Alicia Yap from Citigroup. Alicia, your line is open. Please unmute yourself and go ahead.

Alicia Yap (Equity Research Analyst)

Hi. Thank you. Good evening, management. Thanks for taking my questions and also congrats on the solid quarter. With TME concluding, 2022 with improving margins and also the fundamental trends, I think Sherry just now also commented a little bit of the 2023 outlook. If management can elaborate a little bit more detail in terms of, you know, overall, what are you expecting for the online music revenue growth? Specifically, is there any change on your music subscriber growth target or any ARPPU trend that you are expecting? Also for the social entertainment, do you still expect the revenue to experience the year-over-year declining trend into the 2023? Thank you.

Tony Yip (Chief Strategy Officer)

Thank you for your question. Overall, we currently expect that 2023 will be a year of positive growth for both top line revenues of around mid-single digit percentage, as well as a bottom line net profit of around low teens percentage. In addition, we expect quarterly revenue from our online music services to exceed that of social entertainment services to become our primary source of revenue during some point within this year. This is driven by both China's pro-growth policies at the macro level, as well as our continued investments to strengthen our operations. In terms of online music, we expect subscription revenue to continue to deliver healthy growth of over 20% year-over-year, driven by both growth in paying users as well as ARPPU.

In addition, advertising, long audio, IoT services are all expected to contribute meaningfully to the growth. In terms of social entertainment, while traditional video live streaming continue to face a competitive pressure, our audio live streaming and international businesses can partially compensate by delivering healthy growth. Net-net, that means social entertainment is expected to see a milder rate of decline compared to last year. Combining all of the above with our continued focus on cost management to improve efficiency, we currently expect net margins to also improve into 2023.

Operator (participant)

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

Alex Poon (Equity Research of China Internet)

Congrats management on very strong results. My question is related to gross margin, trend in 2023 and maybe even longer. In 2022, because we have music growing faster than social segment, we are still able to achieve gross margin expansion. How sustainable is this in 2023, maybe even 2024? As music segment, for now, the gross margin is still lower than the social segment, and music continues to grow faster than social. How will our gross margin profile change over the next one to two years? Thank you very much.

Shirley Hu (CFO)

Okay. I will talk about gross margin. Our gross margin is 33% inclusive, increased by 4.2% year-over-year, increased by 0.4% sequentially. There are several positive factors on our gross margin. First, the increase of net adds, monthly apps of music subscription, and the growth of non-subscriber revenue, such as digital album, artist related merchandise, non-form audio revenue will all have positive impact on our gross margin. Second, decrease the efficiency promotion actives and increase the content quality of performance. Revenue sharing ratio of live streaming have been controlled and decreased on year-over-year base. Third, we increased R&C requirement of content cost and optimized the model of R&C.

We restructured the agreements with some music labels, tried to switch MG model to revenue sharing model, or got more reasonable MG, we have the positive feedback. The fourth, the optimized technology and operation strategy related to bandwidth and the storage capability and improved utilization of our service and equipment. Our operational cost decreased on a year-over-year basis and sequentially. While the decrease of social entertainment revenue and change of revenue mix in social entertainment revenue has the negative impact on gross margin. Looking forward to 2023, all these positive factors will be continued, the negative factors also be continued. We will continue to expand the suite of monetization tools such as ad supported advertisement, artist related merchandise, Super VIP membership, the wake fact our online music revenue will keep helps growth.

We will continue to focus on increased efficiency of all business units and tighten our cost terms control in 2023. We expect our gross margin will be increased on a year-over-year basis in 2023.

Operator (participant)

Thank you. Our next question from Lincoln Kong from Goldman Sachs. Lincoln, your line is open. Please unmute yourself and go ahead.

Lincoln Kong (Executive Director)

Thank you management. You, you know, congrats on the good result. My question is on the advertising business. You know, how do we see so far, let's say year to date, you know, advertising demand recovery for us? We talk about this ad support, you know, model. In terms of the new format of ads or in creating more ad inventory, how do we think about our progress here? Especially, how to better monetize our, you know, big MAU in 2023? What's our, you know, outlook here?

Tony Yip (Chief Strategy Officer)

Thank you for your question. You know, we continue to see a recovery in the advertising revenues, especially following the reopening post COVID. The splash screen ad continue to recover at a healthy pace. In addition to that, ad supported mode advertising continue to ramp up and currently account for roughly about mid-teens% of the advertising revenue. Thirdly, in terms of sponsorship advertising, while during the fourth quarter, it temporarily weakened due to COVID, you know, we do expect with the reopening there to be many more live events, and as a result, sponsorship advertising opportunities. All in all, we do expect this year to be a strong recovery year and a year of positive growth for the ad business.

In terms of verticals, in the fourth quarter, we, you know, given the e-commerce seasonality, we did saw an, you know, a meaningful increase in the e-commerce vertical. In addition to that, internet services in general, food and beverages, consumer electronics, as well as local services are also verticals where we saw continued demand from advertisers.

Operator (participant)

Thank you. Our next question comes from Lei Zhang from Bank of America Securities. Lei Zhang, your line is open. Please unmute yourself and go ahead.

Lei Zhang (Research Analyst)

Hi management. Thanks for taking my question, and congrats on all of the results. My question's mainly regarding your sales marketing and investment plan in 2023. Since we have a pretty good cost control last year, so, can you give us more color for 2023? Thank you.

Shirley Hu (CFO)

Okay. About the selling and the promotion expenses, we have taken tight control to our selling and marketing expenses in Q4 continuously, resulting in a 65% decrease on a year-over-year base. We balance the MAUs and the monetization when evaluating the healthiness of business. We focus more on measures such as level of user engagement, user retention rate, and paying users. We will further monitor ROI of each promotion channel and manage the internal and external resources more effectively, improve efficiency of selling and the marketing expenses in the future. In 2023, selling and promotion expenses will be operated at a very low level and will be continued decrease on year-over-year basis, but the cutting degree will be limited compared to those in 2022.

In the 2023, we will invest in the content promotion, so that will be a new way for our upgrading our MAUs. Yeah.

Operator (participant)

Thank you. Our next question comes from Wei Xiong from UBS. Wei Xiong, your line is open. Please unmute yourself and go ahead.

Wei Xiong (Equity Research Analyst)

Hi. Good evening management. Thank you for taking my question. I want to get some of your thoughts around AIGC. As management mentioned, we are exploring possibilities and leveraging technology in that area. How do we assess TME's strategic positioning around AIGC? What are some of the potential benefits and business opportunities that we plan to pursue this year? What could be the potential investments or cost implications related to that? Thank you.

Tony Yip (Chief Strategy Officer)

对 我 们

Ross Liang (CEO)

In the future, we will probably invest more in our own LLM, a large language model. We will invest in our own research and development. In this field, we can drive our subsequent development in areas closely related to music, such as dialogue boxes, as well as image and video generation, including music, including our current songs. We can also see that more and more large models are now being used in music generation to reduce the threshold for music creators. In summary, what we are currently doing is an experience using this LLM. The ultimate core logic is to reduce the thresholds at many of our current stages, because it actually does not affect creativity.

By doing this to improve efficiency and reduce thresholds, we can look forward to the future of such content generated by AI in our actual operation of such a function to get more, very full application.

Tony Yip (Chief Strategy Officer)

We've always invested in AI, in particular recently with a focus in LLM, large language models. Clearly that will lead to more applications. We'll continue to leverage partnerships with Tencent. Examples of our applications would include recommendation as well as playlists in a more conversational setting. Other examples would include music posters, greeting cards, synthetic voice, all of which are already currently being applied to our platform. Into 2023, we'll invest in our own R&D in LLM to drive music-related conversational applications and also to help musicians dramatically reduce the barrier to their creativity. Overall, that should result in more creativity and high quality content, which is good for the overall industry.

Operator (participant)

Thank you. Our next question comes from Xueqing Zhang from CICC. Xueqing, your line is open. Please unmute yourself and go ahead.

Xueqing Zhang (Media Analyst)

Hey, thanks for taking my question. Just a follow-up on ARPPU of music subscription business. We noticed that the ARPU for music side continued to improve this quarter. How does management think about the ARPPU momentum in the first quarter and, in 2023? You mentioned in the prepared remarks it may be driven by optimized content quality, more attractive member privileges, more sales channels, and, more effective promotions. Could you give us more color on this way? Thank you.

Tony Yip (Chief Strategy Officer)

Well, the short answer is yes. We do expect the ARPPU to continue to improve, driven by all the things that we mentioned. A combination of continued improvement in the quality of our membership offering, the quality and the comprehensiveness of the privileges in our membership, you know, more broadened sale channels, which include internal, kind of within platform channels, as well as external, outside of our platform channels, as well as more effective promotions. You know, by more effective promotions, obviously that would lead to a higher ROI when we do engage in promotions which are helpful to ARPU.

Operator (participant)

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

Thomas Chong (Regional Head of Internet and Media)

Hi. Good evening. Thanks management for taking my questions. Congratulations on a solid start of result. My question is about the competitive landscape. Given that in terms of the sales and marketing spending and margin improvement, are we seeing the competitive landscape more stabilized and there's less threat from the short-form video? My second question is about online music services surpassing social entertainment at some point for this year. I just want to get some color with regard to the long-term revenue mix. How should we think about online music services' revenue contribution in the long term? Thank you.

Tony Yip (Chief Strategy Officer)

I'll tackle the second part first about the revenue mix. As we mentioned, you know, we do expect the music, online music services revenue to surpass social entertainment. Clearly what that would mean over the long run, and we expect that to continue in to the long run. We do expect the online music services to be the primary revenue source going forward, as opposed to being a one-off effect. Within online music services, obviously in the fourth quarter, you've seen that, you know, music subscription grow just north of 20%, and then non-subscription revenue grow at a faster pace than that, primarily due to the low base in 2021.

Looking into 2023, we obviously think, you know, that the effects will be slightly different. Music subscription would grow at over 20% on a year-over-year basis, as I mentioned. Non-subscription revenue, you know, we will see pockets of growth in the areas of advertising, which is growing very well, long audio, IoT services, but somewhat offsetted by volatility in digital album as well as sub-licensing.

Operator (participant)

our next question.

Tony Yip (Chief Strategy Officer)

With the unique platform and content strategy of TME is now starting to have some monetization with the content productions, content licensing, and also advertising sponsorship with our live event as well. As we mentioned that we have started to have some artist-related merchandising revenue, which can help us to explore further e-commerce opportunities. Those will also help us to build some new revenue streams in the future.

Operator (participant)

Okay. Thank you. Our next question from Charlene Liu from HSBC. Charlene, your line is open. Please unmute yourself and go ahead.

Charlene Liu (Managing Director and Head of Internet and Gaming of Asia-Pacific)

Thank you so much. I have two question. First, can you share your expectations for subscriber growth for paid music? How should we think about impact from resumption of offline entertainment versus willingness to pay as macro recovers post reopening? That's the first question. Separately, on gross profit margin, I think management had mentioned that it still has room to improve further. What could be a midterm target for GPM? Also I think kind of subset to that question is: How would investment into LLM impact us from a P&L standpoint? Thank you so much.

Tony Yip (Chief Strategy Officer)

I'll take the first part on the subscriber growth, and perhaps Shirley Hu can add a bit of comments around gross margin. You know, our subscriber growth has been following a secular trend. Irrespective of COVID, irrespective of reopening, we continue to see a secular trend behind the subscriber growth. Our focus is much more on subscription revenue as a whole, which is driven by both paying user growth as well as ARPU. Barry, you mentioned offline and more offline activities. I think bear in mind that that also benefit us in the form of advertising monetization, as Cussion Pang mentioned, because we organize a vast number of offline music events, and we generate a meaningful amount of so-sponsorship advertising revenue as a result.

During the fourth quarter, that part of the business actually saw some temporary impact because of COVID. With the reopening and with more offline activities, we actually expect there to be a positive impact to the sponsorship advertising revenue as a result. That would help act as a second growth driver to our online music revenue in addition to subscription.

Shirley Hu (CFO)

About the gross margin of music, we believe we can have the same gross margin rate about came to the Spotify. For the our gross margin of our company, we believe in 2023, our gross margin will be increased and higher than that in 2022. In the long-term gross margin, our target will be 35%. That is mentioned in our IPOs. Yeah.

Operator (participant)

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

Xueqing Zhang (Media Analyst)

Hey, thanks for another question, one more question on labels collaboration. Today we announced that TME reached an agreement with GVR and B Music. Could management give us more color on the future trend on labels collaboration and how does it affect our gross margin? Thank you.

Tony Yip (Chief Strategy Officer)

TME is the preferred partners for many music labels and artists domestically and also internationally. We insist to protect the IP right, and we try our best indeed here to drive the healthy development of the Chinese music industry. Currently, we provide the most comprehensive music library and also the best coverage of music content for users in China. I think that in the long-term relationship, we will continue to work with the music labels in content co-productions and also with our leading music, with our leading technologies that can help us to do the promotions of the musics in a better manner. Besides, we are also focusing on some of the live events. The Chinese market is now reopened, we are seeing that there's a lot of live event opportunity coming up.

For TME live, that we are doing extremely good quality of music shows in last year. Most of them are online. This year, we are going to have more offline events in partners with our music labels partners. We are expecting that we can have more shows like the top-tier artist concerts, music festivals, and also some live house events as well. I think that we have demonstrated a really good long-term partnership with most of the music labels all over the world, and we are the trustworthy and also the preferred partners of them. We have expected to have more in-depth cooperation coming in the future.

Operator (participant)

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

Tony Yip (Chief Strategy Officer)

Thank you everyone for joining us today. If you do have further questions, please feel free to contact our IR team. This concludes today's call. Thank you, and talk to you next time.