YY's CEO Discusses Q4 2013 Results - Earnings Call Transcript

Mar. 5.14 | About: YY Inc. (YY)

YY, Inc. (NASDAQ:YY)

Q4 2013 Earnings Conference Call

March 4, 2014 8:00 p.m. ET

Executives

Charles Eveslage – ICR, IR

David Xueling Li – CEO

Eric He – CFO

Analysts

Timothy Chan – Morgan Stanley

Vivian Hao – Deutsche Bank

Yu-Heng Fan – China Renaissance

Gene Munster – Piper Jaffray

Gregory Zhao – Citigroup

Nick Ning – 86 Research

Alicia Yap – Barclays

Jialong Shi – Credit Suisse

Operator

Good day everyone, and welcome to YY's Fourth Quarter 2013 Earnings Conference Call. [Operator Instructions]

At this point, I would like to turn the call over to Charles Eveslage from ICR. Thank you. Please go ahead.

Charles Eveslage

Thank you, operator. Welcome to YY's fourth quarter 2013 earnings conference call. With us today are Mr. David Xueling Li, CEO of YY and Mr. Eric He, CFO. Following management's prepared remarks, we will conduct a question-and-answer session.

Before we begin, I refer you to the Safe Harbor statement in our earnings release which also applies to our conference call today as we will make forward-looking statements.

At this time, I would now like to turn the conference call over to our CEO, Mr. David Li.

David Xueling Li

Thank you. Good morning and good evening everyone.

2013 was a great year for YY. We enjoyed four quarters of stellar growth in users' engagement activity and financial performance, and ended our first year as a public company with strong momentum heading into 2014.

Because of our powerful real-time interactive social platform, we have seen increasingly diversified and interactive online activities among our expanding base of 92.3 million aggregated monthly active users, which increased by 6% from the previous quarter. In particular, online music and entertainment again outperformed our expectations, with revenues growing by 217% year over year. Through a series of engaging and diversified group entertainment events and activities such as our huge, popular 2013 Annual Entertainment Awards ceremony, we were able not only -- able to not only simulate user engagement -- stimulate user engagement and spending, but also enhance user stickiness on our platform.

The expansion of our user base as well as the success of our monetization efforts drove the IVAS revenue growth which increased by 144% year over year to RMB569 million. In addition, we made several positive developments on the mobile and the education front in particular, that positioned us extremely well to accelerate the development of our brand and expansion of our platform in 2013.

First, in 2013, we were largely successful in driving increased adoption and strengthening the functionality of our mobile application, helping us expand our user base and monetization opportunities significantly. Moreover, we accelerated mobile monetization by launching a payment channel for entertainment activities on our mobile app in October.

Second is our online education offering for which we built a strong foundation for 2013, and only last week significantly expanded upon with the launch of our dedicated education platform, called 100 Education. Eric will discuss these two highlights shortly in greater detail.

Heading into 2014, we are excited to build upon this robust foundation we have established. We will continue to broaden our ability to engage and monetize our users by the further penetration into online entertainment, live broadcasting, education and other verticals.

At this point, let me hand over the call to our CFO, Eric.

Eric He

Thank you, David. Good morning everyone. Now I would like to elaborate upon our mobile and education strategy.

First, in 2013 we focused heavily on driving increased adoption and strengthening the functionality of our mobile application. In October, we accelerated mobile monetization through launching a payment option for entertainment activities on our mobile app. By enabling payment function, our user now can interact with their favorite performers on their mobile devices through the same page features that were previously available only on our PC client. Just within the first couple of months we saw promising results from our online music and entertainment paying users beginning to make payments through mobile devices. Even though the dollar amount is low, we feel it is growing extremely fast.

By integrating the functionality of our entertainment platform across PC and mobile devices, we were able to not only significantly improve user experience on mobile but also accelerate our mobile monetization and expand our long-term business opportunities.

Benefiting from these initiatives, average daily active users of our mobile platform increased by more than 20% quarter over quarter. And average monthly installations increased by 42% year over year to 4.6 million per month.

Second is our education offering, which only last week underwent a massive expansion as we launched a dedicated education platform called 100 Education. Through our portal 100.com, we will freely provide millions of aspiring students in China the opportunity to complete test credits and other courses over our online platform in a real-time and active environment. Prior to the launch of 100 Education in the fourth quarter of 2013, there were more than 30,000 online education institutes and teachers providing lectures, online tutorings on YY's platform. And the number of paying users in December 2013 increased by impressive 340% year over year.

100 Education's launch will provide significant strategic value to us, as it will allow us to capitalize on our robust user base and expand full force into the fast-growing online education market. This bold strategic move will require investments in both product development and business operations as we work to develop our value-added education offerings for our users, which will include 100 Education branded apps on iOS and Android platforms.

With this effort, we aim to offer our users a truly unique and interactive learning experience that is not possible in traditional offline education services. We believe these cost-effective online education programs have potential to both transform traditional means of learning and help us to further expand our user reach and enhance user experience on our increasingly diverse platform.

Now let's take a deeper look at our financial highlights. To begin with, we were pleased that in the fourth quarter, not only were we able to significantly exceed our expectations on both top and bottom-line growth, but we also further increased our profitability with non-GAAP net margin expanding to 35% from 22% a year ago. These results were driven by a greater operating leverage of our platform which has increasingly been able to attract and engage massive audiences through our cost-effective viral online marketing as well as self-promotion from -- by performers and channel owners on our platform.

With this strong performance in mind, I would like to highlight several points. First is that the fourth quarter is a seasonally strong quarter in general. And with combination of our blockbuster yearend awards ceremony, it made the seasonality effect even stronger. Due to that success, we expect our quarter-over-quarter growth comparison to be a bit more modest.

Secondly is to discuss our margin expansion in greater details and show how that was bolstered by the power of our platform. Take our yearend YY Entertainment Awards ceremony as example, through this event, which vastly exceeded our expectations, user could cast paid and free votes for the annual best guild and annual best performers in various different entertainment genres across the platform. This provided innovative chances for users to interact with and endorse their favorite idols and performers. This year the event again turned out to be a huge hit, generating a substantial amount of revenue from users' votes.

Although the event was immensely popular and generated additional increase in sales and ARPU, it only required minimal hard marketing spendings on YY's part. This was because the bulk of the promotion in fact occurred organically within our platform as guild owner and performers found it in their interest to self-promote through soliciting their fans' participation and votes.

As a result of these cost-effective marketing campaigns as well as our overall cost control efforts, our sales and marketing expenses for the quarter, which include one-time reversal of the yearend bonus, actually decreased compared with last year's period. And our non-GAAP operating margin expanded to 36%. These user-driven marketing campaigns and many other activities, enabled by our large audience of registered users, reflects the power of our platform in driving increased user engagement and activities, expanding our monetization opportunities.

Now moving on to our quarterly financial highlights. Before I get started, I'd like to clarify that all financial numbers we are presenting today are in renminbi amounts, and percentage changes are year-over-year comparisons, unless otherwise noted.

Net revenues for the fourth quarter 2013 increased by 130% to RMB612 million. This increase was primarily driven by an increase in IVAS revenue, and to a lesser extent, an increase in our company's online advertising revenues. IVAS revenue increased by 144% to RMB569 million. The overall increase primarily reflected an increase in the number of paying users and an increase in ARPU.

Let's look at each of our IVAS business lines more specifically. Revenue from music and online entertainment increased by 217% to RMB337 million. This increase primarily reflected a 165% increase in the number of paying users to 902,000 and a 20% increase in ARPU to RMB373 during the fourth quarter of 2013.

Revenue from online games increased by 66% to RMB163 million. This increase primarily reflected the increase in ARPU of 41% to RMB376 and the 18% increase in the number of paying users to 433,000. Also, the number of online games increased to 126 as of December 31, 2013 from 73 last year.

Revenue from others increased 141% to RMB70 million. Revenue from membership programs increased by 72% to RMB45 million. This increase primarily reflected a 65% increase in the members to 837,000 as of December 31, 2013. Revenue from live broadcasting of online games increased significantly to RMB21 million from RMB700,000 in the prior-year period.

Online advertising revenue increased by 29% to RMB43 million in the fourth quarter 2013. This increase reflected a 51% increase in total number of advertisers to 92, with average revenue per advertisers of approximately RMB472,000.

Cost of revenue increased to RMB297 million. This was primarily attributable to an increase in revenue-sharing fee and content cost which increased to RMB165 million this quarter from RMB47 million last year. This increase included revenue-sharing fees and content costs to performers, channel owners and content providers, and was primarily due to a higher level of user engagement and spending.

In addition, bandwidth costs increased to RMB16 million, representing 10% of revenues, down from 16% of revenues in the same period last year as we continued to manage the bandwidth cost through better allocation of bandwidth resources and infrastructure improvements.

Gross profit increased by 147% to RMB315 million. Gross margin was 52% compared with 48% in the corresponding period of 2012.

Our non-GAAP operating income increased 261% to RMB220 million. Non-GAAP operating margin increased to 36% from 23% in the same quarter last year. The increase in operating margin was primarily due to increased operating leverage associated with our company's expansion.

GAAP net income attributable to YY increased 478% to RMB192 million from RMB33 in the same quarter last year. GAAP net margin increased to 31% from 13% in the same quarter last year. Non-GAAP net income attributable to YY increased by 269% to RMB217 million, while non-GAAP net margin expanded to 35% from 22% in the same quarter last year.

Diluted net income per ADS increased to RMB3.21, or US$0.53, from RMB0.63 in the same quarter last year. Non-GAAP diluted net income per ADS increased to RMB3.63, or US$0.60, from RMB1.12 in the corresponding period of 2012.

For the first quarter of 2014, we currently expect our net revenue to be between RMB625 million and RMB635 million, representing year-over-year growth of approximately 98% to 102%.

We're very proud that in 2013 we were able to achieve solid financial success, strengthen our offering across the board. In 2014 we aim to leverage this platform and further enable services which cater to Chinese dynamic -- Chinese users' dynamic and ever-changing demands.

This conclude our prepared remarks for today. Operator, we are now ready to take some questions.

Question-and-Answer Session

Operator

Ladies and gentlemen, we will now begin the question and answer session. [Operator Instructions]

And your first question comes from the line of Timothy Chan from Morgan Stanley. Please ask your question.

Timothy Chan – Morgan Stanley

Good morning, David and Eric. Congratulations on a very strong quarter. My question is related to -- on the education. Could you maybe elaborate more on your value proposition here, especially how do you differentiate from offline cost providers in terms of content?

And how would the previously announced RMB1 billion investment in education services impact your margin going forward? Thank you.

Eric He

Okay. I will direct the questions to Xueling. So I would like to translate a little bit to Xueling. I am pretty sure that he understand the question, but I want to make sure that specifically he can answer your question.

Xueling --

Okay. Now Xueling will answer the question in Chinese and I will do the translation later.

David Xueling Li

[Interpreted] Okay. I think the value proposition for our education services actually can be analyzed in three points. Point number one is we want to make sure that a student can get quality education services Number two, that we would like to emphasize that online is really provide a very convenient vehicle for people to learn, at home or anywhere.

Number three, we want to emphasize that online education will create a lot of interactions which is never seen offline. For example, we can allow interactions among students. We can allow interaction between teacher and students. So we will group them in several groups so that they will have better discussions and learning spirits. I think that is the value proposition that we will provide to our students.

Of course, the most -- and most important part of it is it's free of charge.

Okay. We want to emphasize that we want to thank our board to approve this amount of investment in our endeavors in education business. I think we want to emphasize that with this large sum of $1 billion, we are going to invest this money very wisely and in batches in a long-term perspective. So I think in the short term it's not going to affect our financial results that much.

And this invest actually is very broad-based. It includes very long-term investments and acquisitions of our all education resources.

On top of that, we would like to see a lot of the teachers, offline teachers, come to YY platform to teach. So we would like to help them to become their own boss on YY platform because previously all those offline teachers, they have very little or very few opportunity to become their own boss. It involves a lot of risk for them to go out on their own. But come to YY, we would like to do our best to help them establish their business, by giving them a great classroom, virtual classroom, by helping them -- give them some sort of supports when they need it. So I think those are very, very important for a teacher to start their own business on YY platform. If necessary, we may actually help them on a monetary sense.

Lastly, I think we want to emphasize that YY is a company who has never actually throwing lots of money to do marketing campaign in the past. And we are not going to do so in the future for our education business either. So we want to emphasize that the value we created for the students. And also, we will try our best to focus on our education product, so that we would like to use our product or user experience -- a good product and good user experience to attract more students. I think that is going to be our future expansion directions.

Timothy Chan – Morgan Stanley

Thank you very much.

Eric He

Okay. Two more points.

David Xueling Li

[Interpreted] Okay. We said free of charge. In fact it doesn't mean that we will prohibit teachers to collect tuitions from students. I think it's a teacher's own will, whether he or she wants to collect tuitions from students.

We actually say, very clear and loudly, that we are not going to charge teachers any fees in order for them to offer their courses on YY platform. And also some courses actually directly offered by YY, it's free of charge for all the students as well. So we would just want to make sure that this is clear and being understood.

I think I also want to clarify that people may get very scary to say that, oh, we're going to offer free courses and offer the free teaching experience, but here I want to emphasize that usually when we learn foreign language, we would have four teachers, for example, listening comprehension, your speaking capability, your writing capability, and reading capability. So you need actually four teachers to help you. But on an offline situation, you need a lot of teachers in order to help a lot of students.

But the power of YY is that we can leverage on our technology. We can leverage on the capability that we can concurrently hold thousands or tens of thousands or even millions of students. So the number of teachers that we need to engage or hired is only very few. It could be just four, eight, handful of great teachers. And they can actually provide a great service to tens of thousands of students concurrently. So that's why we believe the power of online educations on YY is unparalleled, and so it's not going to cost that much of our cost.

Timothy Chan – Morgan Stanley

Thank you.

David Xueling Li

Thank you.

Operator

Your next question comes from the line of Vivian Hao from Deutsche Bank. Please go ahead.

Vivian Hao – Deutsche Bank

Hi, Eric, David. Thank you for taking my question, and congratulations on an extremely solid set of results.

Just one question here, is how should we think about the live show industry growth potential? And I guess the ultimate question is how we can size the market. In terms of competition, apart from 9158 and Wagwai [ph], et cetera, the direct peers we see that like Youku and NetEase are also introducing their own live show platforms. So how do you think about the competition in the segment? Thank you.

Eric He

Okay. I would like to direct these questions to Xueling. And Xueling doesn't need translation. He understands this question. Xueling please.

David Xueling Li

Okay. Thank you.

[Interpreted] Okay. We think this market is very, very big, by the fact that you have seen so many parties or competitors or companies joining into this market, just like you just alluded to. So we think this market actually is very, very big. Number two is that we actually have not seen too much of cutthroat competition, meaning that we have been growing our business very nicely, as all you can see, in 2013, but we believe other parties in the industry also is growing their business as well. So in many sense that the competition is not that keen. It's because that we actually focus on the different points. So we are targeting at different audience. The business line is somewhat different. I believe that you guys know what we mean.

Number three is that we believe at this point of time it is still at a very embryonic stage of the industry development. We think it's early because the ultimate goal for us is to change the infrastructure or the way that the star can be created. So that would be our direction. We want to focus on how to formulate, to create immensely popular, great star known by everyone. And that is a very difficult and long, hard process.

And this is our commitment. This is our goal. I don't think that everyone agree with us, so we may actually aim at very different directions as other participants in the industry. So we think that the business and industry is very bright. In this industry, of course, it's a long-lasting business.

Vivian Hao – Deutsche Bank

Thank you. May I have one follow-up question here? Speaking of the music industry, can you provide us some more color on your plan for this year, to work more closely with the experienced producers and like from the music industry or just the overall show industry?

Eric He

I would direct the questions to Xueling. I needed some time to translate to Xueling, so I mute the call a little bit.

Now I would like to ask Xueling to answer the question.

David Xueling Li

[Chinese language spoken]

Vivian Hao – Deutsche Bank

Okay, great. Thank you.

David Xueling Li

Okay. Thank you.

Operator

Your next question comes from Alex Yao from JPMorgan. Please ask your question.

Unidentified Participant

Hi, David, Eric. This is Vincent [ph] calling on behalf of Alex. Thank you for taking my questions.

My question is on the game Strife. I think the game has ended the first run of testing in February. So given the success of such mobile game, so what is the initial feedback from gamers? Can management share some operating data on the game? And what is your expectation on the game in terms of users, revenue? Any color would be helpful. Thank you.

Eric He

Yes, thank you for the question. I think Strife is the first game that we actually will license. You're right, it's a mobile game, MOBA. It's one of the hottest genre in the marketplace. When you said that it's being closed beta-ed February 2014, that specifically was actually done on -- in the markets outside of China.

So in China markets, which is a little bit different because we have gone through -- we have to go through a very different process, as you know, that we need to actually get approvals from GAPP, the government regulators, so that I think at this point of time, the test in the Chinese market, it's very limited at this moment.

And from what I know, outside of China, this game has been performing quite well. I think the general feedback from the users are this game is very easy to play and it's very concise. And people just love the way that it presents itself. So in fact, I think according to the developers as to games, they are very confident they should actually turn this game into a very decent popular games in the futures.

But I think this we will have to wait until maybe a couple of month later when they open beta and they will announce this specific performance data. But at this moment, we are still optimistic to see this game is developing into the right direction.

Unidentified Participant

Thank you.

Operator

Your next question comes from the line of Yu-Heng Fan from China Renaissance. Please ask your question.

Yu-Heng Fan – China Renaissance

Hi. Good morning. Thanks for taking my question, and congrats again.

My question is related to online web game broadcasting. Can management provide some color, how should we think about the market size and growth potential for this vertical? And who are your direct competitors, and the potential competition in this vertical? Thank you.

Eric He

I would like to ask Xueling to answer this question. Xueling please?

David Xueling Li

[Interpreted] I think as you all can see that in 2013 our real-time game broadcasting business has been growing very, very fast, has made a tremendous improvement during the years. But we think that this market is still at a very early stage. I think the reason that we haven't seen that so called e-sports or e-competition become a huge business is because of two -- a couple of points.

The point number one is that in the past, people would like to emulate the e-sports as football or basketball. But as you all know that the football population and basketball population is much, much bigger. You know, the competitive games -- competitive online games markets or users is much smaller, user base is much smaller. And so it is very different.

Secondly is because the business model. Because the business model for e-sports in the past, it's very isolated in a sense that -- because when you talk about a football and basketball, the way of play, and it's very similar year by year, it's not going to change. But for e-sports or online, you know, online games, every year it may actually change into different games. For example, you played DOTA this year, and next year you will play DOTA 2. So in this sense it will be -- have a very different content, you know, even that it's only one year's difference.

And in the international markets, in the U.S., we have seen other participants in the industry such as Pudge [ph] as you may have known, that their business model is mainly on advertising, using broadcasting -- game broadcasting as a content to attract advertisers to run advertising dollars on their platform. We think that in the long run, this may not be very optimal or that the great way to monetize this market. So YY actually provides a very different way of monetizing this market. We use virtual items, our type of the monetization of premium micropayment, this type of methodology.

So we think our business model may actually become the mainstream in the future for e-sports or for these competitive games. And we think that this is not only just for PC, PC end, it actually -- real-time game broadcasting can be penetrated or proliferated into console game or even on mobile games. We think this market is just beginning. It has a great future in the next couple of years.

Thank you, Eric.

Yu-Heng Fan – China Renaissance

Thank you. I just have one housekeeping follow-up. You mentioned several factors contributing to your music outperformance in 4Q. I just wonder, how much of that was due to the yearend annual event?

Eric He

Well, to be honest with you, I don't know the numbers. We don’t actually separate out because the event actually happens across, you know, across the quarters, so it's difficult for us to be that specific. So I would just say that the fourth quarter traditionally is a very strong quarter. And because of the events in our music business, it actually make it even more seasonally strong. So it's very difficult to give you a specific number.

But I already said it, that if you look at our guidance number, it's somewhat modest. But if you take two quarters in a row, meaning that you use Q3's number, Q4 number and our guidance for the Q1 numbers, you will see that this Q-over-Q growth rate is still very consistent. It is in the low teens, around 13% Q-over-Q. So we would like to see that -- we would like to think that our business has been growing at a very healthy mode. If you take this as a two quarters period, instead of the one, you know, very big quarter in the fourth quarter. So, you know, yeah, that is my answer.

Yu-Heng Fan – China Renaissance

Okay. That's helpful. Thank you. I'll follow up later. Thank you.

David Xueling Li

Thank you.

Operator

Your next question comes from Gene Munster from Piper Jaffray. Please ask your question.

Gene Munster – Piper Jaffray

Good morning and congratulations. Eric, if you could talk -- I know we talked a lot about education and kind of the mechanics of the business. Can you just remind us as we're kind of modeling this, how we should think about modeling this out for the next maybe one to two years? I realize you are not going to give guidance, but just something helpful, like don’t expect much until x timeframe and so forth would be very helpful. Thank you.

Eric He

Okay. Yes. Gene, thank you for the question. I think as David just mentioned, our education business, the primary goal for our education business in 2014 will be to gain market share, meaning that we are going to attract as many teachers come to YY to establish their own business, become their own boss. And then we believe those good teachers, great teachers will attract more students. So for this year, mostly we will keep track of the number of teachers and the number of students on YY platform.

As Xueling mentioned, David mentioned, that we are not going to charge teachers for any fees using YY's education products. So I don’t expect that we will generate too much revenues in 2014. But from 2015 --

Gene Munster – Piper Jaffray

This is --

Eric He

I'm sorry?

Gene Munster – Piper Jaffray

Yes, yes, that's exactly what I was interested in, 2015.

Eric He

Moving forward, 2015, it's an area that is a little bit too early for us to tell. Certainly we hope that when we approach 2015 a little bit more, then we will tell you whether or when we are going to start to monetize. That will be very -- depending on how much teachers and students or what kind of courses or how we develop our products. So at this point of time, I don’t have any specific guidelines or even a ballpark number for you to understand in 2015, whether we are going to generate gigantic revenues or not that much revenue or no revenue at all.

So I -- to be honest with you, I don’t know about that myself. So we will see the progress of this business to develop.

Gene Munster – Piper Jaffray

That's very helpful. Thank you and congratulations.

Eric He

Thanks.

Operator

Your next question comes from the line of Gregory Zhao from Citigroup. Please ask your question.

Gregory Zhao – Citigroup

Thanks for taking my question, and congratulations on the strong numbers. I have two quick questions.

The first question is still about that RMB1 billion investment in education. So some accounting aspect you mentioned, potentially we are looking at some acquisition of teaching resources. So that means we will capitalize the investment or the investment will directly drop in to be reflected in the P&L.

And my second question is about mobile. So currently, what percentage of our active users are mobile and what is the mobile users paying intention compared to the PC users? Thank you.

Eric He

Well, I think as we just mentioned, David just mentioned that this RMB1 billion investment into the education business does include many areas, including a lot of the education resources or investments, strategy development, and things like that.

Yes, it will actually include possible investments or acquisition of education resources. So in that case, this will become balance sheet assets or investments for the long term. So yes, definitely, I think we are not going to spend this $1 billion on to, you know, P&L related items. So I think that's very clear.

So it's very difficult to gauge what's the impact on P&L. But as Xueling or David mentioned, that in the short run we are not going to see too much impact -- financial impact mainly on the P&L, you know, on the P&L side.

Certainly, I think you mentioned that -- this mobile improvement, yes, our mobile actually is improving quite well. In the fourth quarter, we have seen that lots of mobile users using mobile to pay -- to pay to buy the virtual items. I think, although as I mentioned the amount is not that big, considering only two or three months, but the momentum and the speed of increase, it's very healthy and it's very strong.

So I think over the long term, we think that mobile payment, mobile monetization will become one of the major ways for our users to pay for our items.

Gregory Zhao – Citigroup

Okay. Thank you.

Operator

Your next question comes from Nick Ning from 86Research. Please ask your question.

Nick Ning – 86Research

Hi. Thanks for taking my question. Congratulations on the strong results. My question is, do you expect some deceleration in the gaming business for the whole year of 2014 given the trend we have seen in the past three quarters? And specifically, any progress you can share with us on mobile gaming? Thank you.

Eric He

Okay. I would like to ask Xueling to answer the game question. I think I may actually need to translate a little bit for Xueling's benefit. Just hold on a second. I will mute the microphone a little bit.

David Xueling Li

[Chinese language spoken]

Eric He

Yeah. Let me just translate a little bit on what David just said.

I think as you all see that our gaming business actually has been growing quite consistently. As you all know, that the web game market, it's stabling off a little bit. It's not growing as strong as before. However, we still see that the industry as a whole can grow at somewhere around 20% year-over-year basis in 2014. But if you remember that in 2013 YY's game revenue's growth momentum is twice, double of the industry average. So we would like to think that this type of momentum will continue into 2014.

Not only that, we believe that we see a lot of opportunities in MMO markets. MMO markets in China, as you all know, it's a RMB50 billion market. It's very, very big. It's growing slowly but it's not declining. But the fact that we have seen a lot of content provider, which is the game developers, they are quitting on their foray into this market, meaning that they are not providing too much content into the marketplace. So all of a sudden these markets become much less competitive markets.

So with that kind of observations, we believe we have reasons to see our, you know, licensed games drive may actually perform quite well.

In terms of the mobile game markets, we know that mobile game, at this point, the most important thing is we want to have a big mobile distribution platform which is really relying on a large user base. So we are doing our best to acquire mobile users on our end. We use music, we use our Duowan.com, little blocks here and there, we use videos to attract a lot of the mobile traffic. So when we actually gather enough mobile traffic, then we will become a very important mobile game distributor again. Because YY is a platform which has amassed or accumulated a lot of users and we are very experienced on how to distribute games, so we believe that we still have great future on mobile game distribution.

On top of that, we see that the mobile game industry will be somewhat different from the web game business. The web game business is a business that distribution channels is the key. Web game developers, they have to rely on distribution channels such as YY to acquire users. But on mobile games, we believe that the distribution channel and the content developer or the content providers are equally important.

So from this year on, we are going to dedicate some of the resources to develop some of the mobile games by our own. So in the second half of this year you may see actually mobile game developed by ourselves, and also you will see more of the capability of the mobile game distributions, you know, starting from 2014.

Nick Ning – 86Research

Thank you. That's very helpful. And a quick follow up is, how should we look at your margin trend for the rest of the year given your new initiatives and if Q4 could --

Eric He

Yes, in terms -- hello? Still there? Hello?

Nick Ning – 86Research

Yes.

Eric He

Okay, good. So that was the question, the margin trend. Okay.

The margin trend for 2014, okay, this is what we expect. We believe that 2014 is a year of investment. We need to actually invest in many areas. We need to invest in education, we need to invest in mobile games, mobile platforms, we need to broaden our music offerings. So this of course will cost us money. So I have been trying to tell the investment community that in 2014, please don’t forecast ever-growing margin trend in every quarter. Because in 2013, as you can see, our margin has improved almost every quarter, but in 2014 I think the margin is going to be somewhat flat. So if I were to be able to tell you some kind of guidance, I would strongly recommend that you use average of this margin of 2013 as your benchmark for 2014.

And another point I want to ask is that because the music business has become the number one revenue generator for us, as you all know that we will share roughly 40% of the total revenue numbers or gross proceeds to the singers and to the channel owners altogether. And so for that business, it becomes a large proportion of our revenue. It may actually bring down a little bit of our gross margin compared with previous quarter with the less importance of the music business.

However, because of the operating leverage, our operating margin, will be impacted less by the music business. So the music business become number one, it will actually impact the gross margin a little, bit but to the operating margin it's a flat impact. So I think the bottom line is margin is not going to grow too much, please use the average of 2013 as your benchmark for you to model 2014.

Nick Ning – 86Research

Okay, that's very helpful. And allow me, for my last question, sorry if I missed it, but what is the revenue for our mobile users. Thanks a lot.

Eric He

Our mobile users MAU is roughly RMB17 million in the fourth quarter.

Nick Ning – 86Research

Thank you very much.

Operator

Your next question comes from Alicia Yap from Barclays. Please ask your question.

Alicia Yap – Barclays

Hi. Good morning, David and Eric. Thanks for taking my questions. Congratulations on a very strong quarter. I do have a couple of quick follow ups.

Number one is for the mobile revenues and the new apps, so based on you initial tracking and monitoring of the user, could you share with us what are some of the user behavior difference between the mobile and the PC. And also the demographic difference and also the demographic coverage breakdown?

Eric He

Thank you, Alicia, for the questions. As we mentioned a little bit earlier, that we are very pleased to see our mobile monetization improving quite strongly in the fourth quarter. We have seen that a lot of users and using mobile devices to buy the virtual items. As we mentioned previously, we did not actually have the capability allowing our users to buy through mobile devices. Once we open that up, we have seen that the mobile monetization is growing quite strongly.

And secondly, I think in terms of the engagement, we see that mobile users engage in less time on the mobile devices versus the PC users and I think that is the very strikingly different user behaviors. However, their frequency of using mobile devices, it's a lot more. So we are still seeing that the mobile monetization continue to grow in the first quarter of this year. We believe this number will continue to grow in the future. I think maybe next quarter or in the second quarter we will actually single it out and telling you that what is the breakdown between the mobile and the PC when it reach a certain meaningful levels.

But all I want to say is that we are improving the user experience for mobile monetization and we are seeing quite a lot of usage of mobile devices. And actually that's one of the reason that our mobile's DAU is actually is growing quite strongly as well.

Alicia Yap – Barclays

Just to follow up on that. Do you think a lot of these mobile users are actually your new user that you are able to penetrate now versus previously you are more limited on the PC, or do you think thee se are some of the existing PC user that probably are using both devices now that they have the mobile access?

Eric He

Well, at this point of time I would say both. I would say that the mobile user actually comes from our PC users. I think that's probably a bulk of the users. But we also see some of the new users just using mobile to play our music and talking with their friends and everything. So I do see that it's a mixed bag of both. But all in all, we believe that mobile devices or mobile strategy is going to me important not only for us to accumulate more uses, but also help us to generate more revenue in the future.

Alicia Yap – Barclays

Sure. And then just lastly, one quick follow-up on the mobile gaming on sequential trend questions earlier. So I think with the sequential decline in the paying user and the year-over-year growth may decelerate, is that mainly the cannibalization from some user that are paying now more mobile games or is that seasonality and how should we expect the trend for the next couple of quarters? Thank you.

Eric He

Well, I think that the paying users for our gaming business is still -- has room to grow and I believe that you know, during the course of the business development, sometimes it is very difficult to control every or to expect every metrics to grow in a straight line. So sometimes you will see a little bumps and down the road. It's quite normal. But when you see the number of paying users in our game business as a total active users, it's still the number is very, very low. I think there's a great potential for them to grow their business into the future.

So I think this number is just aberration in the fourth quarter. I think in the quarters to come, the paying users should actually get back to a healthy development course. So I see that our gaming business should continue to grow at a very healthy pace.

Alicia Yap – Barclays

Thank you.

Operator

Your next question comes from Jialong Shi from Credit Suisse. Please ask your question.

Jialong Shi – Credit Suisse

Hi. Good morning, David, Eric. Thanks for taking my call. I have a few follow-ups. Firstly, if I understand correctly, Eric, were you just saying your gross margin will likely drop slightly in 2014 but your operating margin will remain resilient? And also what's your tax rate for 2014 and 2015? Thank you. I have one follow-up.

Eric He

You know, it's awfully difficult to pinpoint if our gross margin will up or down or our operating will be up or down. But I just want to point out a couple of points. As I mentioned, the 2014 is a year of investments. So, as you know, that our business creates lots of operating leverage. So the operating leverage will be generated from hiring less people but our growth rate is much bigger than spending on payrolls or sales and marketing or G&A expenses. So for that point of business, still will be true. However, because we are going to add a lot of headcounts into our total employee base, so it's going to take out some of the margin.

So that's why I want to caution you that in 2014 our margin level is not going to be similar to 2013 as you see that it is growing almost every quarter. So I would like to ask you to use 2014 average -- 2013's average as a benchmark to model 2014. And specifically, I think the gross margin, as I emphasized it, when the music business grow a little bit, and then you will see, because of the 40% revenue shares with performers and channel owners, this creates some pressures for the gross margins to go up.

So I think, yes, as music business grows bigger and bigger, our gross margin is likely to be trimmed down 1 or 2 basis points -- percentage points, 1 or 2 percentage points. However, the operating margin should be impacted very little. So the operating margin should hold up quite well.

Jialong Shi – Credit Suisse

And how about the tax rate?

Eric He

The tax rate will be quite normal, will be somewhere around 15%.

Jialong Shi – Credit Suisse

Got that. And also I think Xueling mentioned earlier one of the education -- 1 billion education investment will be acquiring education resources. Could you elaborate what product assets in education in YY might be interested to buy? And also, we have seen quite a lot of companies and fresh capital swarming into this online education area in the past years. So could management elaborate what particular strength YY might have to compete against your rivals? Thank you.

David Xueling Li

[Interpreted] Well, yes, we will be looking at the business that -- who has experience operating systems and experience in the past, and we also are interested in some specific professional verticals who has generated very, very good results. So those are the areas that we are interested in.

Jialong Shi – Credit Suisse

So what particular strengths YY might have to compete against other education companies?

David Xueling Li

[Interpreted] Well, because YY has very mature and strong technology platform, which will allow a lot of people to capitalize on their content. So we think that a lot of the companies should actually think that YY is a great platform to work with.

Jialong Shi – Credit Suisse

Thank you. Finally, a housekeeping question, for your advertising business. The ARPU saw a very drop in Q4. Could you give some color on that?

Eric He

Well, the advertising business in Q4 is because they rolled out very low-priced products and so there is a lot of demand for our advertisers. So all of a sudden, a lot of low unit price tickets comes in, which actually sort of diluted the unit price and increased the number of the advertisers for that business. So that is the main business.

I think it's not going to be a future trend. So it's -- I think it's just a one-time product redesign type of thing.

Jialong Shi – Credit Suisse

Got that. Thank you very much.

Operator

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may all disconnect.

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