Earnings Call Transcript - HUYA Q3 2020

Dana Cheng, Investor Relations

Hello, everyone, and welcome to HUYA's 2020 Third Quarter Earnings Conference Call. The company's financial and operational results were issued earlier today and are posted online. You can also view the earnings press release by visiting the IR website at ir.huya.com. A replay of the call will be available on the IR website in a few hours. Participants on today's call will be Mr. Rongjie Dong, Chief Executive Officer of HUYA; and Ms. Catherine Liu, Chief Financial Officer. Management will begin with prepared remarks, and then the call will conclude with a Q&A Session. Before we continue, please note that today’s discussion will contain forward-looking statements under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, the company's results may be materially different from the views expressed today. Further information regarding these and other risks and uncertainties is included in the company's prospectus and other public filings as filed with the U.S. SEC. The company does not assume any obligation to update any forward-looking statements, except as required under applicable laws. Please also note that HUYA's earnings press release in this conference call include discussions of unaudited GAAP financial information, as well as unaudited non-GAAP financial measures. HUYA's press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited most directly comparable GAAP measures. I will now turn the call over to our CEO, Mr. Rongjie Dong. Please go ahead.

Rongjie Dong, CEO

Hello, everyone. Thank you for joining our conference call today. We achieved solid results this quarter and importantly, the investments we have made in content, products, and services are continuing to drive the growth of HUYA’s businesses and user communities. In Q3, our total revenues grew by 24% year-over-year to RMB2.8 billion, while our gross profit increased by 53% year-over-year to RMB621 million, keeping us in a strong position to fund our future growth and capture the opportunities ahead. Despite a relatively shorter summer vacation period due to the impact of COVID-19 in China, the average MAUs of HUYA Live still grew to 173 million in Q3, a net addition of over 4 million from last quarter and up 18% year-over-year. Additionally, on average, over 25 million users each month during the quarter watched HUYA’s live streaming content across Tencent and other third-party platforms, nearly doubling last quarter. Altogether, we provided our compelling content to close to an average of 200 million users every month in Q3. The growth was mostly driven by the increase in e-sports tournaments, as well as a deeper cooperation with Tencent. In Q3, our live streaming content was broadcasted on Tencent’s various products, such as QQ Mobile, WeGame, WeChat, Game Center, and YoYo game. Specifically, our live streaming content related to the Labor Day All-Star Tournament attracted a larger number of users on QQ mobile. Our mobile MAUs of HUYA Live reached 74 million in Q3, representing a year-over-year growth of 17%, but slightly lower than last quarter due to the relatively shorter summer vacation period and a higher base for the first half of the year caused by COVID-19. However, our HUYA Live apps' next month retention rates continuously stabilized at over 70% in Q3. Our success in delivering solid financial results and continuous user growth underscores our capabilities in driving monetization and user engagement. Our thriving community reflects our team’s continuous efforts, along with deeper cooperation with Tencent to enrich content and make our products and services more innovative and attractive, delivering even greater value to ensure a superior user experience. In September, we upgraded our HUYA Live app to version 8.0, featuring new functions such as live events, instant playback, video clip generation, and sharing, a smart AI assistant, and a real-time monitoring panel. With these new functions, users can choose any specific time interval within a live streaming event, mark e-sports event highlights, and generate video clips from live streams to share with friends. Furthermore, there is a smart assistant on top of the app featuring AI-enabled interactions to enhance the viewing experience. Our technology partnership with Tencent also allowed us to create a real-time monitoring panel for e-sports tournament broadcasting. With this new panel, our hardcore viewers can obtain more information on the tournament and better analyze the game's status. We believe these upgrades represent an exciting opportunity to innovate, provide a new experience for our users, and grow our user base. In October, we formed a joint venture with Tencent to carry out joint technology efforts in various fields, such as AI security applications, irregular activity detection, data security, and data undertaking. We believe we can work together to improve AI-driven compliance on the platform and enhance the industry's health. Since we launched our open platform for third-party application developers in November last year, we have empowered a growing number of third-party developers to create tools used in HUYA’s products, primarily to improve interactions between broadcasters and users. It’s been almost a year, and we are glad that there have been around 160 tools developers and over 300,000 broadcasters using these tools by the end of Q3. We are confident our open platform will enhance interactions between broadcasters and users with innovative and dynamic features. During the recent LoL World 2020, which concluded at the end of October, we introduced new features and functions to make the S10 broadcast on HUYA more innovative, immersive, and game-integrated. In addition to our upgraded 8.0 app, we also provided users with a high-definition and latency-free viewing experience in 4K. We introduced our virtual broadcast, Hulu, to interact with real-person broadcasters and viewers to improve the experience. We also launched Tencent-supported S10 live viewer passports. With this viewer passport, HUYA users will be able to earn rewards, game accessory items, or game schemes once they complete certain engagement activities during tournaments, such as sending quality checks, virtual gifting, or real interactions. Lastly, I would like to share some thoughts on the ongoing merger with DouYu. On October 12, 2020, we announced that we have entered into a merger agreement with DouYu, where we plan to acquire all the outstanding shares of DouYu through a stock-for-stock merger. Once the merger is effective, each ordinary share of DouYu will be exchanged for 7.30 Class A ordinary shares of HUYA, and each DouYu ADS will be exchanged for 0.73 HUYA ADS. If the merger is completed, the shareholders of HUYA and DouYu will each hold approximately 50% of the shares of the combined company on a fully diluted basis. Concurrent with the merger, DouYu will buy Penguin e-Sports from Tencent for US$500 million. We believe the potential combination will allow us to build on our complementary strengths, achieve significant synergies, and create more value. By joining together with DouYu and Tencent’s professional team, we are reinforcing our commitment to constructing a comprehensive online destination for gaming and e-sports-related content. With that, I will now turn the call over to our CFO, Catherine, to share her insights on the operating metrics and financial details. Catherine, please go ahead.

Catherine Liu, CFO

Thank you, Mr. Dong, and hello, everyone. Following Mr. Dong’s remarks, I will start with the updates on content enrichment and diversification. In Q3, we broadcasted 119 third-party e-sports tournaments. Among these, the top tournaments included our awards 2020, LPL 2020 Summer, HoK World Champion Cup, LCK, and KPL for 2020. Total viewership for these tournaments reached a historic high of around 785 million in the third quarter, representing 40% year-over-year growth. On the front of our self-produced content, we organized 34 e-sports tournaments and entertainment shows and generated a total viewership of 100 million, representing 32% year-over-year growth. Following its success last quarter, HUYA’s Destiny Cup Season 7 maintained its growth momentum and attracted more users than last season. Additionally, HUYA All-Star Cup Summer 2020 also performed well and established itself as a signature event on HUYA’s platform. On the entertainment side, GodLie Season 5, a long-standing werewolf game show, All-Star Idle Academy, a talent show, and HUYA Kung Fu Carnival Season 2, a mixed martial arts competition, were our top-performing shows, as we continued to enhance our efforts in non-gaming entertainment content. Talking about the traffic this quarter, our average MAUs increased by 18% year-over-year to a record high of 173 million, and average mobile MAUs reached over 74 million, representing an increase of 16% year-over-year. The paying users of HUYA Live increased by 13% year-over-year to 6 million in the third quarter but decreased slightly compared with 6.2 million in the second quarter. The fluctuation in our mobile MAUs this quarter, due to the short summer vacation period and the impact of COVID-19, resulted in the quarterly fluctuations in our paying users. The live streaming revenue per paying user for HUYA Live remained strong and increased both year-over-year and quarter-over-quarter. For our overseas business, we achieved over 30 million MAUs in the third quarter. The better-than-expected growth was primarily driven by more e-sports tournaments, increased broadcasters, and deeper relationships with local game developers. Next, I will walk you through our financial highlights. In Q3, our total net revenues grew by 24% year-over-year to over RMB2.8 billion. Our live streaming revenues increased by 23% year-over-year to close to RMB2.7 billion in Q3. The growth was primarily due to the increase in the number of paying users and the increase in revenue per paying user, both of which expanded. Advertising and other revenues increased by 45% year-over-year to close to RMB158 million in the third quarter, primarily supported by an increasing and diversifying number of advertisers. Our profitability continued to improve this quarter given the leverage we have in bandwidth costs and our operational efficiency. Our non-GAAP gross margin improved to 22.7%, compared with 18.3% in Q3 2019. Our non-GAAP operating margin was 11.8%, compared with 6.5% in Q3 last year, and our non-GAAP net margin was 12.8%, compared with 9.1% in Q3 last year. Now, let me move on to our financial details. Cost of revenues increased by 18% to RMB2.2 billion for Q3, primarily attributable to the increase in revenue sharing fees, content costs, and personnel-related costs. Revenue sharing fees and content costs increased by 21% to RMB1.8 billion in the third quarter, mainly due to the rise in revenue sharing fees related to higher live streaming revenues, and increased spending on content creators, e-sports, and self-produced content. The year-over-year increase was partially offset by benefits from economies of scale. Bandwidth costs decreased by 1.4% to RMB208 million for the third quarter, primarily due to improved bandwidth cost management and continued technology enhancement efforts. Gross profit increased by 53% to RMB621 million for the third quarter, with gross margin rising to 22% for the third quarter. Research and development expenses rose by 35% to RMB183 million for the third quarter, mainly attributed to increased personnel-related expenses. Sales and marketing expenses increased by 18% to RMB144 million for the third quarter, driven primarily by increased marketing expenses in the summer to promote the company’s content, products, services, and brand name, as well as higher personnel-related expenses. General and administrative expenses rose by 23% to RMB119 million in the third quarter, mainly due to increased professional fees associated with the company’s ongoing merger process with DouYu. Operating income surged by 249% to RMB223 million for the third quarter, and operating margin increased to 7.9% for the third quarter. Non-GAAP operating income, which excludes share-based compensation expenses, increased by 125% to RMB331 million for the third quarter. Non-GAAP operating margin rose to 11.8%. Income tax expenses increased by 82% to RMB51 million for the third quarter. Net income attributable to HUYA Inc. rose by 105% to RMB253 million for the third quarter, while non-GAAP net income attributable to HUYA Inc., which excludes share-based compensation expenses, rose by 75% to RMB361 million for Q3. Diluted net income per ADS was RMB1.05, and non-GAAP diluted net income per ADS was RMB1.5 in the third quarter. As of September 30, 2020, the company had cash and cash equivalents, short-term deposits, and short-term investments of RMB10.8 billion. Along with the merger announcement mentioned earlier, our Board of Directors also approved a cash dividend of US$200 million to be paid around the date of the merger's closing to the holders of ordinary shares of HUYA, including the holders of ADS as of the close of business on a designated record date after the DouYu shareholder approval is obtained and prior to the merger's closing. This record date and payment date will be announced in due course. An update from today includes our acquisition of usage rights for a piece of land about 29,258 square meters in Foshan City, Guangdong Province, won through a public auction for approximately RMB310 million. The company intends to develop office space on the land to accommodate future workforce expansion and reduce long-term operating costs and expenses. With that, I would now like to open the call to your questions.

Operator, Operator

Thank you very much. Ladies and gentlemen, we will now begin the question-and-answer session. For the benefit of all participants on today's call, if you wish to ask your question to management in Chinese, please immediately repeat your question in English. And our first question comes from the line of Thomas Chong of Jefferies. Please go ahead.

Thomas Chong, Analyst

Thanks, management, for taking my question. My question is more about the 2021 outlook, specifically in terms of user growth, revenue, and profitability trend, as well as how we should think about the synergies with Tencent and DouYu, if there's any color at this stage? Thank you.

Catherine Liu, CFO

Thank you, Thomas. I will answer your questions. Currently, we're still in the process of the ongoing merger, and we expect the merger could possibly be completed in the first half of next year. At this stage, it's still too early for us to provide quantitative impact details of the merger. However, for the general direction, we still aim to grow our users, explore new monetization opportunities, and increase revenues while also improving our operational efficiencies. Regarding the potential synergies with DouYu and Penguin, we believe there are several avenues that could generate synergies, such as leveraging our content over a larger user base to attract users, developing new products together, exploring new monetization opportunities, and achieving some operational efficiencies.

Operator, Operator

Thank you for the questions. Next question comes from the line of Vincent Yu of Needham and Co. Please go ahead.

Vincent Yu, Analyst

Thank you, management, for taking my question. My first question is about the content strategy. How should we think about HUYA's content strategy going forward, especially after the merger? Or will we see a shift from our current gaming and pan-entertainment content offering? The second question is about the users’ willingness to pay; are we seeing any changes in our top-paying user cohorts or in different categories like gaming and other entertainment categories considering COVID has primarily affected only China?

Catherine Liu, CFO

Regarding our content strategy for next year, there are several aspects to discuss. Firstly, we aim to build a one-stop shopping concept for a gaming content-related family bucket. This means not only focusing on game live streaming but also including videos, game communities, and game-related tools, ultimately providing a comprehensive content and service offering. Specifically on the video strategy for next year, we have been conducting our research and road mapping for the video business and are confident that within two years, we will significantly grow our user base in this area. About the potential impact of the merger on our content strategy, both platforms have excellent content quality that is complementary. In 2021, we aim to consolidate our content offerings to better serve game developers, broadcasters, talent agencies, and users, enhancing the role of game live streaming across the industry value chain. Regarding your second question about paying users, as you can see in Q3, our paying users per ARPU has increased both year-over-year and quarter-over-quarter. Generally, we are seeing a recovery from the effects of COVID-19 in China. We will continue to enhance our content offerings and improve monetization opportunities to increase our ARPU. However, different content categories have varying ARPU, and seasonality impacts it as well. Typically, our ARPU is lower in Q1 due to the spring festival and tends to be higher in Q4 with annual monetization events. Hope I answered your questions.

Operator, Operator

Thank you for the question. Next, questions will come from the line of Binnie Wong of HSBC. Please go ahead.

Binnie Wong, Analyst

Hello. Good evening, management. My question is on overseas users on Nimo TV. This quarter, you also added 3 million net new users, achieving the 30 million target a quarter earlier than expected. Can you share the strategies or acquisitions that helped you achieve this 30 million level, and what synergies do you see with DouYu overseas in the future? Thank you.

Catherine Liu, CFO

Regarding your first question about overseas growth, we have seen remarkable overseas MAU user growth this quarter. As mentioned in the last earnings call, our focus in overseas markets this year has been on improving the ecosystem and cultivating a better monetization model. We have been reducing costs for channel buying to acquire new users, and despite this reduction, we've achieved considerable user growth, demonstrating that our strategy to build out the ecosystem is effective. Going forward, we will focus not only on substantial user growth but also on constructing a healthy ecosystem. This year marks our third year developing the overseas business, and we are gaining insights into better building the business in overseas markets. Regarding potential synergies with DouYu overseas, I believe both parties are still in the early stages of exploring the overseas market, so our focus is more on collaboration rather than competition. I believe this combination will create synergies in the overseas business.

Binnie Wong, Analyst

Sorry, may I just ask a very quick follow-up? Looking at the margin side, at what point do you see the overseas business becoming more profitable in the long run? How do you anticipate overseas margins compared to domestic?

Catherine Liu, CFO

In October, we began to see one specific country achieving a relatively breakeven operating margin. However, we believe that for the entire overseas business, we will need to invest for the next few years as different countries exhibit varying user behaviors. In some countries, ARPU or paying ratios are higher than in others. Therefore, we think that for the next few years, the overseas business will mainly be in the investment phase. As Mr. Dong mentioned earlier, we will focus on building a healthy ecosystem in each country.

Operator, Operator

Thank you for the questions. Next question comes from the line of Billy Leung of Haitong International. Please go ahead.

Billy Leung, Analyst

Thank you, management, for taking my questions. I have two questions. The first is related to cloud gaming progress. Can management share some insights on our latest developments in this area? Secondly, regarding the relatively new game companion speech service, can management share any latest developments on that front as well? Thank you.

Rongjie Dong, CEO

Regarding your first question on cloud gaming, we would like to highlight that the technology platform for our cloud gaming platform, Yowa, is entirely developed by our R&D team. We have invested significant time to reduce latency and optimize user experiences while they are playing mobile and PC portal games via our Yowa cloud gaming platform. In fact, we just officially launched this Yowa cloud gaming platform after nearly four months of beta testing, and we currently feature around 100 game titles. Our goal is to enhance users’ experience, for example, through better viewing angles and seamless gameplay. Given that it has just launched, we will promote it effectively to see how the market responds to this cutting-edge technology. We believe there are tremendous opportunities ahead with the cloud gaming business, and we are committed to realizing those opportunities to bolster our business. However, in the short term, we might need to observe a bit longer to see if users are ready for a massive transition to this experience. Catherine will now address your second question.

Catherine Liu, CFO

As for your second question concerning the game companion business, it continues to experience rapid growth, particularly for our app. We believe the game companion business is showing solid growth. The accounting treatment for the game companion business is distinct from our virtual casino; we recognize only net revenues for the game companion business. While the uptake of the game companion business is significant, its revenue contribution remains small. However, from an accounting perspective, the game companion business presents much higher margins than virtual gifting. Hope this answers your question. Next.

Operator, Operator

Thank you for the questions. Our next question comes from the line of Daniel Chen of JP Morgan. Please go ahead.

Daniel Chen, Analyst

I have two questions. The first concerns what management sees as the key opportunities in game streaming and video industry over the next two to three years, both from the product and monetization perspectives. The second question pertains to competition; what do you consider to be our key competitive advantages against Kuaishou or Bilibili, given their aggressive pursuit of top hosts and gaming broadcasting rights? Additionally, Kuaishou has surpassed 200 million game-streaming MAUs, which is substantial.

Rongjie Dong, CEO

Regarding your question about the competitive landscape with Kuaishou and Bilibili, I will start with Bilibili. The transformation of VTubers to traditional broadcasters has limited Bilibili's impact on the traditional game live streaming industry. In contrast, Kuaishou’s competition is noticeable; however, our year-over-year growth remains strong. Although Kuaishou is significant due to its user base, the impact on game live streaming differs greatly. At HUYA, we are proactively focusing on content development, building a robust content library, while Kuaishou is more centered on establishing a community ecosystem with centralized operation policies. Historically, our strength has been in alliances with industry players like talent agencies and broadcasters, giving us an advantage over Kuaishou’s competition. We aim to leverage these collaborations to enhance operational efficiency, drive user growth, and improve our monetization capabilities.

Operator, Operator

Thank you for the questions. In the interest of time, the last question comes from Lei Zhang of Bank of America. Please go ahead.

Lei Zhang, Analyst

Can you share any thoughts on the engagement with our platform during the League of Legends Season 10? What is driving our gross margin in the fourth quarter? Additionally, regarding regulatory changes, especially concerning live streaming, can you share any insights?

Catherine Liu, CFO

Regarding the S10, we've noticed that engagement has increased compared to last year; however, the incremental growth this year is relatively lower than the previous year. Most of the S10 activities will occur in the fourth quarter, meaning the associated costs will mostly impact our gross margins during that time. Regarding your second question on regulatory matters, we are cooperating with the government, and we understand that certain authorities are working on new guidelines. We are actively engaging with them, and once actual guidelines are issued, we will evaluate their impact on our business at that time. We believe that the intent behind these regulations is to better the role of live streaming in the long run, and therefore, we don’t anticipate significant long-term impacts on our business.

Lei Zhang, Analyst

Thank you.

Dana Cheng, Investor Relations

Thank you all for joining our earnings conference call today. If you have further questions, feel free to reach out to [email protected]. We look forward to speaking with you next quarter. Thank you. Bye-bye.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect your lines. Thank you.