Earnings Call Transcript - TME Q1 2022

Operator, Operator

Ladies and gentlemen, good evening, and good morning, and thank you for standing by. Welcome to the Tencent Music Entertainment Group First Quarter 2022 Earnings Conference Call. Today, you will hear discussions from the management team of Tencent Music Entertainment Group followed by a question-and-answer session. Please be advised that this conference is being recorded today. Now I will turn the conference over to your speaker host today, Mr. Tony Yip. Please go ahead, sir.

Tony Yip, CSO

Thank you, operator. Hello, everyone, and thank you all for joining us on today's call. TME announced its quarterly financial results today after the market closed, and the earnings release is now available on our IR website at ir.tencentmusic.com, as well as via newswire services. Today, you will 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, 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 the IFRS in the company's earnings release and filings with the SEC, where you are reminded that such non-IFRS measures should not be viewed in isolation or as an alternative to the equivalent IFRS measure. The other non-IFRS measures are not uniformly defined by all companies, including those in the same industry. With that, I'm pleased to turn over the call to Cussion, Executive Chairman of TME. Cussion?

Cussion Pang, Executive Chairman

Thank you, Tony. Hello, everyone, and thank you for joining our call today. In today's entertainment landscape with various choices, those who provide users with a unique experience will maintain a competitive edge. In the first quarter of 2022, we focused on developing new professional and personal interactions based on our dual engine content and platform strategy, while also enhancing the scale, quality, and competitiveness of our music catalog. We aimed to improve user experiences through innovations centered on our four pillars of music entertainment: listen, watch, sing, and play, which will help us achieve long-term success and support the healthy growth of the music industry. Our commitment to energizing original content production continues as we leverage our technology-driven production abilities and promotional strengths. The advantages of our overall content ecosystem are becoming increasingly apparent. Through initiatives like the Xingyao Plan and Galaxy Plan, we empowered original content production by using our technology-driven solutions to enhance value across different stages of production, distribution, and promotion. Our middleware platform supports high success rates for original content with features such as algorithm-driven screening for lyrics and demos, AI voice matching from a vast library, and a targeted promotion system that utilizes real-time data analysis to help artists and songs gain traction. Thanks to these advanced technologies, our artists have produced noteworthy pieces, including the hits Mirage and Drown, which topped several music charts with peak daily streams exceeding 13 million. We also refined our original content catalog with a particular focus on key areas like gaming, Chinese Ancient Style, and pop music. In the first quarter, we worked with Tencent Games on popular titles to create unique themed music content that has reached the top of various charts and increased our revenue. A notable hit from the Chinese Ancient Style even became the background music at the Beijing Winter Olympics, generating over 2 billion views on social media and topping TME's music charts. Our Tencent Musician platform is dedicated to supporting musicians at every stage of their careers, helping them showcase their talent to a broader audience. We have been working hard to improve our platform and services for musicians, making it a preferred and habitual space for creators. In the first quarter, we introduced a new behind-the-scenes music production service with over 50 respected industry professionals and more than 100,000 creators offering production support. We’ve also enhanced our platform infrastructure for musicians with a self-service toolkit to manage their work efficiently. These tools empower musicians to promote their work and reach wider audiences, fostering a dynamic musical ecosystem. Moreover, the Tencent Musician platform encourages artists with diverse creative opportunities and promotional resources, helping them reach larger audiences and gain attention on social media. We have established sustainable monetization models for musicians, distributing over RMB 200 million from our platform in the past year to support indie musicians. Enhancing our content library and expanding our reach across various music genres remains a priority, which strengthens our reputation among enthusiasts and increases our connection with high-value users. Our Chinese Ancient Style music initiatives continue to perform well as we recently launched a variety show in China featuring top musicians across 41 genres to create original music that blends traditional Chinese culture with modern styles, earning over 300 media accolades for promoting cultural heritage. In addition, we are broadening our focus to genres like electronic, classical, and anime by teaming up with musicians and labels to provide a full spectrum of content. By the end of the first quarter, more than half of the top 100 DJs had joined QQ Music, enhancing connections with Chinese fans and promoting electronic music trends. Lastly, committed to fostering a sustainable industry, TME is working to create inclusive music charts that accurately reflect and assess the Chinese music landscape. The TME Chart, along with data-driven and expert review-based charts, provides a robust music rating framework. In the first quarter, we published the TME Music Chart Annual Review, offering insights into 2021's Chinese music scene and drawing significant social media attention. Our daily motivation comes from the unique value we can deliver to music lovers, creators, and the music industry as a whole, and we are dedicated to fostering loyalty and engagement through empowerment. Now, I will hand the call over to Ross, who will discuss our platform strategies in more detail. Ross, please proceed.

Ross Liang, CEO

Thank you, Cussion. Hello, everyone. Moving on to our platform strategy. In the fourth quarter, we continue to invigorate our ecosystem and innovate around the four pillars of our music entertainment experience: listen, watch, sing, and play. Beginning with the smallest details, we continuously polish our products to meet the multifaceted needs of diverse cohorts and have strived to create a sense of belonging, making our products a must-have in our users' daily lives. By listening to our users' core demands, we are providing innovative and professional product features to elevate users' listening experience. Technology is so deeply embedded in our corporate character that it has become part of our DNA. QQ Music was the first in China to launch advanced listening functions, including the digital music enhancement engine, which can significantly improve sound quality with one simple click, and replay and gapless playback, which help equalize music volume and deliver an unparalleled music listening experience between consecutive song plays, particularly compatible with classical music streaming. These new functions have been well received as millions of users incorporate this feature into their daily practice. We have also optimized our smart recommendation filter and have become more in tune with our users' tastes, as demonstrated by QQ Music's recommendation penetration rate reaching a new record high by the end of the first quarter, along with recommendation streaming volume and time spent, both recording stronger double-digit growth year-over-year. In addition, our upgrade QQ Music popularity index with real-time updates on the number of listeners online expanded the music coverage, and additional song information has considerably strengthened users' sense of participation, with their input directly influencing a song or artist's prominence. The second pillar of our overall multisensory entertainment experience offering is watch. We are deepening our collaboration with Weixin Video Accounts to create vibrant music scenarios and strengthen music promotion capabilities. In March, the Tencent Musician platform hosted a large-scale, live charity concert during the pandemic, titled Spring Never Ends. It was an 8-hour uninterrupted mesmerizing performance by 141 groups of well-known artists, alongside a roster of other musicians. Supported by Weixin Video Accounts' promotion capabilities and our ability to mobilize the resources on our platform, the concert attracted millions of viewers, generating over a 30% increase in the number of viewers in participating musicians' live streaming rooms on the event day. We are proud to share that by the end of the first quarter, daily video views of Weixin Video Accounts for musicians on our Tencent Musician platform had exceeded 100 million, representing over a 70% increase quarter-over-quarter. Beyond video, our efforts on the visual front also include the use of graphics and other formats to enrich streaming content; music's common display function and the streaming realizations are just a few of the many examples launched in the first quarter. In terms of sing, we were the first in the industry to offer song tune without requiring earbuds via an easy-to-use function that can substantially improve the song effects of songs recorded without internal devices. Another new feature that has inspired widespread accolades among users is our cloud-based song mixing, which helps produce nearly studio-quality song mixing within just two minutes after the music work is uploaded to the cloud. We have also endeavored to expand music entertainment scenarios, adding more fun play elements to the music entertainment experience. We hosted our first radio earnings call on TMELAND, and are planning to organize additional future events, such as facial avatar concerts and customized events on this exciting new virtual music playground in the second quarter. Additionally, we have dedicated virtual rooms for artists, including recently launched rooms for certain artists, which provides immersive interactive social scenarios, where fans can listen to their idol's digital albums anytime, anywhere, while posting song reviews, talking with other fans, and displaying self-inspirations through virtual avatars. We are proud to share that by pairing innovations in the four pillars of music entertainment—listen, watch, sing, and play—QQ Music has achieved solid initial results, as demonstrated by its continuous year-over-year MAU growth. Building on complementary components to our music entertainment ecosystem, we continue to grow our long-form audio business with increasingly differentiated content. We are delighted to see mid- and long-tail podcasts flourishing within the TME ecosystem and gaining traction, thanks to our large user base. For example, after participating in TME's podcast creation center in 2022, podcast host Lao Shi Qi's audio work of the Northern Time Raiders racked up 23 million streams within one month upon its release and shot to the top of TME's charts, leading to substantially higher financial gains for Lao Shi Qi and inspiring a growing number of mid- and long-tail creators to join our podcast ecosystem. Secondly, we enhanced our strong content operation with popular IPs, particularly in TV drama series through audiobooks, artist participation in community activities, and other channels. We're successfully promoting both the audiobooks and the associated IPs, with highlights in the first quarter, including several successful dramas. During the release of these dramas, TME's long-form audio offers of the same title song surged in streaming value. Going forward, we will leverage our membership to maximize the monetization potential of long-form audio as we also continue to optimize content ROI and the DAU monetization efficiency to improve profitability. As we drive our business progress, we remain dedicated to undertaking our social responsibilities to create a better world and promote creative experiences through music. To celebrate the 15th World Autism Day, we launched an autism charity project, Shape of Music, which presented a series of artworks, such as our first public welfare digital single, The Brightest Star, the music album, Symphony of the Galaxy, and the Shape of Music art exhibition, allowing music to not only be heard but also seen and treasured through the crossover of different content and art forms online and offline. The entire net income from the project was donated to autism institutions to advocate for social connections with autism groups. With that, I would like to give the floor to Tony to review our business operations. Tony, please go ahead.

Tony Yip, CSO

Thank you, Ross. Hello, everyone. In terms of operating results in the first quarter, our online music MAUs were 604 million, down slightly year-over-year. Despite the churn of casual users who opted for other pan-entertainment platforms, we are encouraged by the progress we've made in our original content production capabilities, music catalog, and innovative product features, which continue to strengthen the engagement of our core user cohort. Our IoT service MAU continued to witness a double-digit year-over-year increase in the first quarter, which was primarily attributable to our comprehensive IoT entertainment content, integrating music, singing, live streaming, long-form modules, and more. In the first quarter, we worked with Little Genius smartwatch and multiple electric vehicle manufacturers such as Nio, Weili, and others to provide karaoke functionalities on IoT devices. Due to macro headwinds, our online music revenue decreased year-over-year in the first quarter. However, our fundamentals remain healthy, and we successfully sustained our growth momentum in subscriptions. We achieved a net add of 4 million in the first quarter and a paying user penetration rate of 13.2%. At the same time, user retention remained largely stable. For the remainder of 2022, we are committed to delivering a healthy balance between paying user growth and ARPPU, which reflects the quality of growth in our online music business. In the first quarter, as the pandemic weighed on our advertising business, we continue to implement innovative, diverse advertising solutions to unlock more ad revenue potential. To fully leverage our large user base, we are testing a free listening mode where users can listen to songs for 30 minutes for free with every 15 seconds of video rewarded ads that they watch. In addition, our music promotion service and playlist bonus tasks, which allow for accurate targeting of the right audience and increase in streaming volume and popularity of selected songs for a fee, have both achieved early success with strong growth in their daily revenue streams. We also forged ahead with new business models to enrich user experience and monetization avenues. In the first quarter, we launched our Super VIP membership, which complements the two existing tiers of our subscription plan and incorporates up to more than 50 privileges, including access to more music, audio content, as well as digital albums for a monthly fee of RMB 30. Additionally, in the first quarter, we continued to explore the tie-ins between celebrity artists with our music pets, digital collectibles and other projects. To captivate more Gen Z users and cultivate a young and trendy cultural community, we have further embraced our deep roots in the college campus scene and spared no effort in bringing more promising voices to be heard with our campus musician cultivation plan, Vala Campus. In the first quarter, we are particularly proud of the positive impact we have had on female campus musicians, including the winner of the first prize scholarship of Vale Campus, and Chinese folk musician Georgina Chen, who created the Chinese ancient style original work Mulan, based on the classic heroine. With this song, Georgina bloomed on the CCTV program Sing My Heart, exemplifying female bravery and spiritual power. We were also instrumental in her collaboration with household names and brands, such as the award-winning lyricist and others, to produce original theme songs, thus helping her achieve accelerated professional growth and broader recognition. Now let's turn to our social entertainment services. Both MAU and paying users were affected during the quarter by seasonality as well as macro headwinds. Facing the challenging landscape, we will continue to improve our competitiveness through ongoing product innovations and new initiatives in social entertainment such as audio live streaming, international expansion, and virtual interactive product offerings. For WeSing, to achieve our goal of making singing more fun and recording more professional, we provided innovative, easy-to-use features and tools to elevate users' singing and playing experience and to energize the relationships among our users. Our investment in these innovative singing and playing tools in the past few quarters has started to pay off, as the adoption rates and the user time spent in our singing room both improved year-over-year and quarter-over-quarter. Facing competition for our traditional live streaming services, we will strive to generate more differentiated content and user experiences. Firstly, we continue to make progress in vertical content category expansion. Focusing on the women's economy, Kugou Live launched The Goddess Festival event in March, which successfully attracted female users with premium ARPPU to enjoy our audio live streaming routes. Our audio live streaming business achieved a double-digit year-over-year increase in revenues in the first quarter and will become a key component of our overseas development strategy due to higher monetization efficiency in international markets. We also attracted WeSing's target user base by adding live streaming educational content, addressing the needs of seniors, online learning, and sharing needs such as lessons on square dancing, calligraphy, and traditional Chinese crafts. Secondly, cross-platform collaboration is another way we can differentiate. For example, our first real-time live singing event, Meet, co-hosted by QQ Music Live Streaming and WeSing, brought premium karaoke content to live streaming. QQ Music Live Streaming advanced steadily, with the number of hosts increasing rapidly and daily active host reaching a record high of 10,000 during the first quarter. In conclusion, we kicked off 2022 by facing challenges head-on, but we remain confident as we execute our dual engine content and platform strategy. We will persist in making our ecosystem, content, and product differentiated and highly specialized, which in turn will help us capture the hearts and minds of hundreds of millions of music lovers and unlock the massive opportunities in front of us. 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. Actually, I'll discuss our results from a financial perspective. Our total revenue for Q1 2022 was RMB 6.6 billion, down by 15% year-over-year and by 20.7% sequentially. In the first quarter of 2022, our IFRS net profit was RMB 649 million, and the non-IFRS net profit was RMB 939 million, which represented a sequential increase of 8% as a result of our focus on operating performance. In the first quarter of 2022, music subscription revenues continued healthy growth with revenues of RMB 1.99 billion and a year-over-year growth of 18% as we benefited from expanding sales channels and paying user growth using high-quality content and the services we provide. Online music paying users grew to 80.2 million, up 32% year-over-year, represented by 4 million net add sequentially. Our ARPPU was RMB 8.3 this quarter compared to RMB 9.3 in the same period last year as we offered more effective promotions to attract users. Taking out the impact from fewer calendar days in Q1, ARPPU maintained stable sequentially, as we focused on the quality growth of our overall subscription revenue. Revenues from advertising dropped year-over-year and sequentially, as our advertising business continued to be negatively impacted by the investor adjustment and seasonality. Our advertising revenues were also impacted by the outbreak of COVID-19 and the lockdown in some major cities. We are proactively expanding our ad inventory, optimizing the display, and rolling out innovative advertising formats to manage these challenges. While we expect ad growth to continue being affected in the short term due to headwinds from regulation and regional COVID-19 outbreaks, we remain confident about the long-term growth potential and expect advertising revenue to start recovering in the second half of 2022. Sublicensing revenues also dropped on a year-over-year basis and sequentially due to the restructuring of agreements with certain music labels. Social entertainment services and other revenues were RMB 4 billion, down by 21% year-over-year as we face an evolving macro environment and intense competition from other entertainment platforms. To adapt to the changing environment and stabilize revenue scale, we have demonstrated our content offerings by enriching our interactive product offerings and expanding our international footprint, as discussed earlier. Gross margin in Q1 was 28%, down by 3.5% year-over-year due to several factors. First, given the continuous growth in music subscription revenue, our revenue mix shifted, with revenues from online music, which generally have a lower gross margin, accounting for a higher percentage of revenue. Second, revenues from audio live streaming, which have a relatively lower gross margin, also grew faster and accounted for a higher percentage of revenue. In addition, the decrease of advertising and sublicensing revenues also impacted the margin. Meanwhile, our tight control on content costs with increased ROI requirements, as well as a lower revenue sharing ratio for the social entertainment business, had a favorable impact on gross margin on a sequential basis. Now moving on to operating expenses. Total operating expenses for Q1 2022 were RMB 1.3 billion or 20% as a percentage of total revenue, which was relatively stable compared to last year. Taking out the impact from the acquisition of Lazy Audio, operating expenses as a percentage of revenues would have been slightly lower year-over-year. Selling and marketing expenses were RMB 330 million, down by 51% year-over-year. During the quarter, we implemented measures to improve efficiency, closely monitoring the performance of each promotion channel, largely with large external promotion channels and leaning on our internal resources to attract users and promote our brand. General and administrative expenses were RMB 1 billion, up by 15% year-over-year, excluding the impact of approximately RMB 44 million from the acquisition of Lazy Audio; G&A would have increased by 10% year-over-year. The increase was driven by a higher number of employees in R&D as we invested in targeted investments, technology innovation, and more diversified product offerings. Meanwhile, we have been closely monitoring employee-related expenses and taking actions to manage headcount effectively, leading to a reduction in G&A expenses on a sequential basis. Our effective tax rate for Q1 2022 was 12.2% compared to 11.5% in the same period of 2021. The increase in effective tax rate was mainly due to some of our entities being entitled to different tax benefits in 2021 and 2022. Our net profit was RMB 649 million, and net profit attributable to equity holders of the company for Q1 2022 was RMB 609 million. Non-IFRS net profit was RMB 939 million, and non-IFRS net profit attributable to equity holders of the company was RMB 899 million. Non-IFRS net profit margin was 14.1%. As of March 31, 2022, our combined balances of cash, cash equivalents, term deposits, and short-term investments were RMB 25.9 billion, representing an increase of RMB 1.2 billion from December 31, 2021. Looking forward, we will continue to focus on our community and invest in new products and services, including platform audio and international growth, with a focus on investment returns and future growth potential. Meanwhile, we will continue to effectively control country-related costs and selling and marketing expenses to improve overall operational efficiencies. This concludes our prepared remarks. Operator, we are ready to open the call for questions.

Operator, Operator

Our first question will come from Alicia Yap with Citigroup.

Alicia Yap, Analyst

I have a question about how the lockdowns and COVID have affected us. Could management elaborate on Tencent Music's overall situation, particularly regarding the prolonged lockdown in Shanghai? Has it had any positive effects on the time spent on online music or the active user engagement in social entertainment? Additionally, have you noticed any increase in user demand or time spent on long-form audio or podcasts? Lastly, have there been any negative impacts on consumer spending willingness or behavior?

Tony Yip, CSO

Sure. In terms of traffic on the music side, as a result of various investments in the innovative features that we have been making over the past several quarters, particularly in QQ Music, we actually did not see any meaningful negative impact from the lockdown. As we reported during the early remarks, we actually saw a year-over-year increase in MAU with QQ Music. With regard to the social entertainment side, specifically with leasing and the online singing components of that product feature, we actually saw a slight increase in online singing activities as a result of people spending more time with karaoke during their quarantines. However, with respect to revenues, there was a meaningful impact on advertising revenue as a result of a large number of our advertising customers being in lockdown situations in major cities. Additionally, it had an impact on our live streaming revenues because both the hosts were also affected in terms of their activities and affected users' willingness to spend on live streaming.

Operator, Operator

Our next question will come from Alex Poon with Morgan Stanley.

Alex Poon, Analyst

My question is related to our music ARPPU trend. Since the beginning of this year, we have started scaling back some of the promotions to balance between the growth of net adds and ARPPU growth, and we are also launching new membership programs which have a very high ARPPU. So how should we think about the ARPPU trend from the second quarter, third quarter, and fourth quarter onwards?

Tony Yip, CSO

Yes. Thank you. Let me spend a minute to talk about the overall subscription revenue growth because that plays hand in hand with the ARPPU trends. Our overall goal for subscription revenue year-over-year growth this year is to achieve close to 20% for the full year. There are two ways to achieve this objective. The previous approach was to focus on subscriber net adds of 3.5 million to 4 million per quarter, which translates to approximately 20% subscriber growth counting from the end of last year. The ARPPU has seen a slight downward trend. The new approach that we'll be implementing going forward is to strike a better balance between subscriber growth and ARPPU. We will work on improving the ARPPU through fewer promotions and measures such as Super VIP that we mentioned. As a result, we expect the ARPPU to increase going forward with Q1 as a base. For subscriber numbers, because of the better ARPPU growth, we can have lower quarterly net adds than the 3.5 million to 4 million range that we previously discussed. Overall, we expect to achieve close to 20% growth in subscription revenue with a healthier mix of ARPPU improvement and subscriber growth.

Operator, Operator

Our next question will come from Xueqing Zhang with CICC.

Xueqing Zhang, Analyst

And my question is related to the Tencent ecosystem, especially cooperation with WeChat. Since there are many new functions launched on WeChat, could management share with us the key directions of cooperation and what functions are particularly helpful? And I wonder how that helps with the operational data?

Ross Liang, CEO

In the interest of time, I'll just spend a quick minute on this. We continue to deepen our cooperation with WeChat with the overall objective of making music an important part of social use cases. There are several areas of our cooperation. It includes things like in the Weixin profile, users can change the profile based on the music that they've been listening to. In the Weixin audio call ringtone, they can now customize using music from QQ Music. During Weixin chat, users can directly share music from QQ Music. Regarding video accounts, we continue to see very rapid growth in operating metrics such as daily video views. With respect to live concerts, that's also a key area where we are looking to expand our cooperation. We've done many successful live concert events such as those with Leslie Chong, Mayday, etc. These events increasingly incorporate a monetization element, such as ad sponsorships. Overall, we provide a robust music content vertical to enrich the video account content ecosystem for Weixin. In return, Weixin provides complementary promotional capabilities, and we assist them with artist partnerships to strengthen that collaboration.

Cussion Pang, Executive Chairman

Besides the content distribution and promotional capabilities that we mentioned working with Weixin, I think there's one more important point: we are working with them closely on the program development side. This includes online concerts; we are not just distributing but also working on the detailed production to ensure high-quality online music concerts are delivered to our users. This is a top priority for the TME team and also the Weixin Video Account team. Having been under the Tencent corporate umbrella for a long time, we work closely peer-to-peer, side by side. We are really working together to create synergies. We look forward to providing even more high-quality content through this platform. Beyond video, the top tier will include these concerts. We are also working on long-tail and high-potential musician content. So, expect much more wonderful content in the future; we have a lot more to come.

Operator, Operator

Our next question will come from Eddie Leung with Bank of America Merrill Lynch.

Eddie Leung, Analyst

Could you talk a little bit about the outlook for your live streaming business for the rest of the year, especially given recent regulations on host taxation problems and protection of minors?

Tony Yip, CSO

In terms of the outlook for the full year, in the last earnings call, we said that for the full year 2022, we were expecting total revenue to decline to around mid-single digits. That was prior to a number of recent regulatory announcements, such as the ones you mentioned, as well as the very recent impact from pandemic measures. Without those impacts, obviously, the previous guidance would have continued to apply. However, following these recent pandemic measures and the latest regulations, specifically the live streaming one that you brought up, which comes into effect in June, we're likely to see live streaming revenue impacted for the rest of the year. The new regulation and new restrictions surrounding tip ranking and performance during live streaming sessions will come into effect next month. We're not yet in a position to quantify that impact for you at this point because the details will depend on the execution and implementation of those restrictions. We will work closely with the regulator to ensure full compliance. To offset some of these challenges, we will continue to invest in building new opportunities, particularly in social entertainment, mainly around audio live streaming, where some of the recently announced restrictions are less prevalent. Additionally, we see opportunities in international expansion within our social entertainment business, particularly in Southeast Asia, Japan, and the Middle East. Furthermore, as we continue to build our metaverse experience through our pioneering virtual music playground, TMELAND, we will host more exciting and interactive virtual events to create a new form of social entertainment.

Operator, Operator

Our next question will come from Wei Xiong with UBS.

Wei Xiong, Analyst

My question is on margins. Management mentioned a few factors that affected our gross margin just now. So I wonder how we should think about the gross margin trending in the next few quarters? And together with our focus on efficiency improvements this year, are there areas where we see potential for further cost savings? And how will that impact the net margin for this year?

Shirley Hu, CFO

Okay. Gross margin is 28% in Q1, down by 0.8% sequentially. The main reason is the quick drop in advertising revenue, which has a higher contribution margin. During Q1, there were some positive factors for gross margin. The revenue sharing ratio for social and Tencent businesses has been controlled and decreased sequentially. Second, adapting to the new macro environment, we increased the ROI requirement across all content. We restructured agreements with some music labels that have had a positive impact on our gross margin. Looking forward in 2022, we expect our gross margin to increase in the next quarter if our social entertainment revenue can stabilize. We will focus on increasing revenue across all business units and cost items. For operating margin, controlling costs and expenses will be a top priority this year. We have taken tight control on selling and marketing expenses in Q1, resulting in a 51% decrease on a year-over-year basis. We will continue to monitor each promotion channel closely and manage internal and external resources more effectively to enhance our selling and marketing efficiency. To improve profitability, we will invest in new products and business segments, such as long-form audio, international expansion, and the musician program. We will pay more attention to optimizing organizational alignment and improving headcount efficiency. Looking forward to 2022, we expect our adjusted net profit to increase sequentially, with our adjusted net margin meeting or exceeding that of 2021, and our music business reaching operational breakeven.

Operator, Operator

Our next question will come from Ronald Keung with Goldman Sachs.

Ronald Keung, Analyst

I want to ask about the pricing side on subscription. Given that the ARPPU has fallen over the past few quarters, with the COVID and macro impact, we believe that the competition has been quite rational. I want to hear about the pricing trend outlook. When will we see stability in ARPPU for subscription? Any iterations on the long-term paying subscriber targets?

Tony Yip, CSO

Yes. I think, as I previously mentioned, the new approach we will take for our subscription revenue is to balance between subscriber growth and ARPPU growth. Even though our recorded ARPPU for Q1 saw a slight sequential decline, that was mainly due to the lower number of days in Q1. If we adjust for that, the ARPPU for Q1 versus Q4 is fairly stable. Using Q1 as a base, we are actively working to improve ARPPU through fewer promotions and other measures such as bundling Super VIPs. Therefore, we expect ARPPU to increase as a trend with Q1 as a base. We discussed subscriber numbers, and because of improved ARPPU, we anticipate lower quarterly net adds than the previously discussed 3.5 million to 4 million range. But we still expect to meet our target of close to 20% subscription revenue growth for the full year.

Cussion Pang, Executive Chairman

Yes. We are encouraged by the strong growth of our online music subscription business, especially under the macro headwinds. The subscription rate has surpassed 30% right now. We will continue to bring in more high-quality content into the subscription plan that our users express value for, making them willing to pay for it. Regarding ARPPU, we can also drive it by, for example, launching new VIP plans with additional privileges at a higher price than our regular offering. We can also explore different avenues for monetization, working with various business partners on new promotional channels. Overall, we believe our online music subscription business is developing in a healthy manner.

Operator, Operator

Our next question will come from Thomas Chong with Jefferies.

Thomas Chong, Analyst

Given the amount of cash that we have at the end of Q1, and looking into our strategies going forward, how should we prioritize cash usage? Are we going to pursue more M&A for international market share, share buyback, or considering dividends? Can I also inquire about the progress on the Hong Kong listing by way of introduction?

Tony Yip, CSO

In terms of our cash utilization, obviously, we will be very disciplined and prudent with our cash management. We have announced that we will continue to fully complete our share repurchase program by the end of this year. As of the latest date just before the earnings release, we have already spent over RMB 670 million on share buybacks since March last year, and that’s a sizable percentage of our current market cap. At this stage, we have no intention to declare dividends. With respect to M&A, we will continue to carefully assess strategic opportunities, both overseas and domestically, in areas complementary to our core music and social entertainment businesses. Regarding the Hong Kong listing, last quarter, we mentioned that we started pursuing the Hong Kong secondary listing. We are currently in an active execution phase and will strive to move things forward in an expedited manner, seeking the necessary regulatory approvals in due course. To the extent there are significant developments, we will make the appropriate announcement.

Operator, Operator

Our next question will come from Charlene Liu with HSBC.

Charlene Liu, Analyst

I wanted to ask about the new ad monetization model. I think in the last quarter, you mentioned a freemium mode that allows users to unlock music subscription services by watching ads. Can you share with us the progress on this in terms of user penetration and feedback from ad clients more generally? And do you have any long-term targets for revenue from this mode?

Tony Yip, CSO

Yes. Sure. Advertising overall saw some impact due to recent regulations on splash screen ads as well as the pandemic measures. A large number of our major advertisers are based in those cities, and therefore the advertising revenue has been affected, resulting in a year-over-year decline in Q1. However, if we look at subcategories within our advertising revenues, we see positive momentum in selected new ad formats, particularly the video incentive ad you mentioned. We continue to increase the penetration rate of new ad products; the revenue from this new format is growing sequentially despite the challenging overall ad environment. It's currently a low single-digit percent of our advertising revenue, but we expect it to grow and become a more significant portion over time. In the long run, despite the short-term challenges, we expect significant potential in the advertising business and anticipate a recovery in the second half. We do see certain sectors that are showing strength, such as traditional consumer staple products continuing to perform well, as well as online games as people spend more time on online games during quarantine. Conversely, areas such as cosmetics and electronics have seen some weakness in advertising verticals.

Operator, Operator

We are now approaching the end of the conference call. I will now turn the call over to your speaker host today, Mr. Tony Yip, for closing remarks.

Tony Yip, CSO

Yes. Thank you, everyone, for joining us today. If you have further questions, please feel free to contact our Investor Relations team. This concludes the call today. We look forward to speaking with you again next quarter. Thank you and bye for now.

Cussion Pang, Executive Chairman

Thank you. Bye.

Shirley Hu, CFO

Thank you. Bye.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.