Tencent Holdings Ltd

HKEX:700

Earnings Call Transcript 2018-Q1

[Operator]

Thank you for standing by, and welcome to the Tencent Holdings Limited 2018 First Quarter Results Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today. I would now like to hand the conference over to your host today, Ms. Jane Yip from Tencent. Please go ahead, Ms. Yip.

[Jane Yip, executive]

Good evening. Welcome to our 2018 First Quarter Results Conference Call. I'm Jane Yip from the IR team of Tencent.

Before we start the presentation, we would like to remind you that it includes forward-looking statements, which are underlined by a number of risks and uncertainties and may not be realized in the future for various reasons.

Information about general market conditions is coming from a variety of sources outside of Tencent.

This presentation also contains some unaudited non-GAAP financial measures that should be considered in addition to, but not as a substitute for, measures of the company's financial performance prepared in accordance with IFRS.

For a detailed discussion of risk factors and non-GAAP measures, please refer to our disclosure documents on the IR section of our corporate website.

Let me introduce the management team on the call tonight: We have our Chairman and CEO, Pony Ma; President, Martin Lau; Chief Strategy Officer, James Mitchell; and Chief Financial Officer, John Lo.

Pony will kick off with a short overview. Martin will discuss our value-added services and social networks. James will speak to online games and advertising, and John will discuss the financials before we take your questions.

I will turn the call over to Pony now.

[Huateng Ma, executive]

Okay. Thank you, Jane. Good evening, everyone. Thank you for joining us.

In the first quarter of 2018, we launched several successful products and further deepened our engagement with users across our social games and media platforms. We continued investing actively in our strategic priority areas such as video, payment, cloud, AI and Smart Retail to fulfill our mission of enhancing the quality of life via Internet services.

For the first quarter of 2018, total revenue was RMB 73.5 billion, up 48% year-on-year and up 11% quarter-on-quarter. Non-GAAP operating profit was RMB 25.3 billion, up 36% year-on-year and up 16% quarter-on-quarter. Non-GAAP net profit attributable to shareholders was RMB 18.3 billion, up 29% year-on-year and up 5% quarter-on-quarter. And John will provide more details in the financial section.

Moving on to our key platforms. Combined MAU of Weixin and WeChat increased 11% year-on-year to 1.04 billion, as Mini Programs continued to gain wider adoption among users and developers. Total MAU for QQ was 805 million. Smart devices MAU was 694 million, up 2% year-on-year. Our news feed service KanDian within QQ continued to grow user traffic and time spent. Our social network services, Qzone smart devices MAU was 550 million.

In games, we maintained our leadership in mobile and PC. In particular, on mobile, QQ Speed Mobile became one of the top 3 grossing smartphone games in China soon after its launch in last December. Our in-house developed a tactical tournament games achieved great popularity both in China and internationally. We also expand the number in variety of Mini Games within Weixin.

For our media business, we maintained our leadership in online video, news, music services and literature. Together through users' short-session entertainment desire, our standalone mini video app, WeiShi, will feature its content in our newsfeed type of product.

In fintech, our mobile payment service continued to lead by MAU and DAU and sustained rapid growth in off-line commercial transactions.

In mobile utilities, we maintained our leading position in China in mobile security, mobile browser and Android app store.

Martin and James will discuss further in business review.

[Chi Ping Lau, executive]

Thank you, Pony, and good evening, good morning to everybody.

In the first quarter of 2018, our revenue grew 48% year-on-year, of which the VAS segment represented 64% of total revenue and of which online games contributed 39% and social networks 25%. Online advertising was 14% of total revenue. Others segment account for 22% of total revenue. In the other segment, fintech delivered triple-digit year-on-year revenue growth, mainly driven by fast-growing off-line commercial transaction fees collected from merchants as well as cash withdrawable fees collected from consumers to cover bank handling charges. Cloud services revenue more than doubled year-on-year, as we expanded our cloud services market share in the games and video industries and rolled out customized solutions catering to financial and municipal services clients. We're also attracting an increasing number of smart retailers such as supermarkets, chain stores and leading fashion retailers to adopt our cloud solutions as they transition businesses to Internet and mobile.

Now diving into the Value Added Services. Segment revenue was RMB 46.9 billion in the first quarter, up 34% year-on-year or 17% quarter-on-quarter. Social networks revenue was RMB 18.1 billion, up 47% year-on-year and up 16% quarter-on-quarter.

The year-on-year revenue growth was primarily driven by the rapid uptake of video subscriptions benefiting from our exclusive video content, increased payment penetration and music live broadcast services and more item sales in smartphone games.

Within the quarter, video subscription revenue grew 85% year-on-year. Sequentially, the increases in game-related items sales, video subscriptions and monetization of WeSing were the main contributors to growth.

As of quarter end, our total VAS subscriptions increased by 24% year-on-year to 147 million, with the growth primarily coming from our content subscription services.

Online games revenue was RMB 28.8 billion, up 26% year-on-year and up 18% quarter-on-quarter. Year-on-year revenue growth was driven by smartphone games, including Honor of Kings and QQ Speed Mobile. PC games revenue were broadly stable, reflecting players time shifting to mobile.

Sequentially, new smartphone games such as QQ Speed Mobile and MU Awakening contributed to revenue growth. Leading PC titles benefited from seasonal promotion activities as well during the quarter. With 4 highly popular tactical tournament games in our portfolio, we have built global leadership in this competitive genre which we'll talk about more on a later slide.

In social networks, on the Weixin front, the launch of Mini Games has achieved significant success. Hence, it's benefited the overall Mini Program ecosystem as a whole with retail -- Smart Retail Mini Programs as one example.

Mini Games have enjoyed rapid expansion in first quarter after opening up their platform for game developers. Currently, we have over 500 Mini Games on the platform. We believe Mini Games are meaningfully expanding our game audience with over 1/3 of Mini Games players not being previous players of Tencent mobile game apps. They facilitate new players to discover game apps. Some users start by playing Mini Game version of app-based game and then progress to downloading the game app. Mini Games also serve as an entry point for users to learn and extend their usage of other Mini Programs.

We have started light monetization of Mini Games via advertisement and some virtual item sales.

Leveraging on growing consumer adoption of Mini Programs, we've introduced our Scan-to-Buy solution. The solution integrates Mini Programs with Weixin Pay, allowing customers to pay for their goods on smartphones, increasing checkout efficiency. Supermarket chains such as Walmart and Yonghui are among our early adopters of the solution.

Our DAU and daily transaction volume for the retailer category of Mini Programs increased 50% quarter-on-quarter. We believe Mini Program is synergistic with the overall app ecosystem because it encouraged many otherwise non-app developers to embrace the mobile Internet. And some of these developers would eventually come on to develop native apps.

Turning to QQ, which has been quite successful in building its content ecosystem in recent years. Its newsfeed service, KanDian, is benefiting from the significant synergies between a social platform and a content platform. In the first quarter of this year, KanDian achieved over 80 million DAU and grew its video views 3x year-on-year. Monetization is still at an early stage, and we see upside potential given the strong advertiser demand for feeds ad inventory.

During the quarter, we've also relaunched our mini video app, WeiShi. WeiShi offers users a wide range of high-quality professional user-generated content or PUGC for the market as well as from our licensed digital content libraries such as music, games, sports and variety shows. In addition to broadcasting the content in the app itself, WeiShi also distributes content to our feed verticals such as KanDian and Mobile QQ browser. We believe WeiShi will be able to leverage our access to proprietary content, distribution capability via our platform apps as well as linkage to users' social graph over time.

Now I would like to turn to James to talk about games.

[James Mitchell, executive]

Thank you, Martin. Tactical tournament games have become phenomenally popular both internationally and in China across PC, console and mobile devices. I'll talk a little bit about how we've capitalized on this new opportunity by utilizing our in-house game development skills, our relationships with IP owners, our investee company portfolio and our publishing platform.

Our in-house game studios in China have developed 2 titles based on the well-known PUBG IP, one reflecting the original PC game play and one featuring a design for mobile experience. The 2 games achieved breakout popularity in China with combined DAU exceeding 50 million users. Outside China, combined DAU grew to over 10 million users, and we've just started monetization. We expect these games to negatively impact our financials in the short term as we are not yet monetizing the games in the China market, but we are incurring marketing and operating expenses. However, we believe they represent substantial revenue opportunity once we commence domestic monetization.

Our investee studio, Epic Games, based in North Carolina has developed and operates Fortnite, which has become a global success. Fortnite has over 40 million monthly active users and is the most-watched game currently on Twitch. It's already achieving healthy monetization via the sales of seasonal battle passes, which unlock skins and decorative items. Fortnite's iOS mobile version ranked as top grossing game in the U.S. iOS chart in April. During the second quarter, we have started preregistration for Fortnite's PC version in China.

Our licensor, PUBG Corporation, has enjoyed global success on PC and Xbox with its PlayerUnknown Battlegrounds game, which has sold over 45 million copies globally in the past 12 months. And we're also working toward publishing a localized China PC version of PlayerUnknown Battlegrounds.

Moving on to smartphone games as a category. Revenue was RMB 21.7 billion, up 68% year-on-year and up 28% quarter-on-quarter. Within the quarter, key titles grew strongly year-to-year in DAUs, paid user and ARPU as competitive mid-core games gained player's mind share and timeshare.

Sequentially, seasonal promotions during the Chinese New Year on our new game, QQ Speed Mobile, contributed to revenue growth. During the first quarter, we operated the top 2 revenue grossing titles in China, namely, Honor of Kings, which grew DAUs by double digits year-on-year. Sales of special skin items drove ARPU and strong revenue growth. We are beta testing new play modes and content for Honor of Kings with the aim of growing its user base and creating educational value for younger players. And secondly, QQ Speed Mobile, which demonstrated our ability to migrate an internally developed franchise, QQ Speed, from PC to mobile and expand the franchise's audience during that migration. The mobile DAU for this game is 7x higher than the highest-ever achieved PC DAU, and over 40% of users QQ Speed Mobile and user franchise not having previously played the PC version of the game.

For PC client games, revenue was RMB 14.1 billion, flat year-on-year and up 10% quarter-on-quarter. Active users declined year-on-year due to continued time shift to mobile, as smartphone games are providing increasingly comparable experience versus PC games. However, core user engagement with our key PC titles remains firm.

During the quarter, content updates and seasonal promotions during the Chinese New Year contributed to the sequential revenue growth. Dungeon & Fighter, which has celebrated the tenth anniversary of its China launch in June, delivered a record revenue quarter, demonstrating our capability for sustaining the longevity of our key game franchises.

We'll continue to invest in new franchises and in genre leadership in areas, including tactical tournament games where we're going to publish Fortnite and PlayerUnknown Battlegrounds into the China market, sports games where we'll release updates of FIFA and NBA2K and sandbox games where we have 3 licensed titles in our pipeline.

As young people are spending an increasing amount of time on live broadcast platforms, discovering games and watching e-sports events, we're deepening cooperation with the market-leading streaming platforms, including Douyu and Huya to better promote our games.

Shifting to advertising. Our first quarter revenue was RMB 10.7 billion, up 55% year-on-year and down 14% quarter-on-quarter. Mobile contributed over 90% of our advertising revenue. Our media advertising revenue was RMB 3.3 billion, up 31% year-on-year though down 20% quarter-on-quarter. Within the media advertising revenue, our video advertising revenue was up 64% year-on-year due to more preroll ads benefiting from the growth in video views and also from our enhanced capability to develop creative app formats within our original content. Our video and news revenue both decreased quarter-on-quarter due to negative seasonality.

Our social and other advertising revenue was RMB 7.4 billion, up 69% year-on-year and down 10% quarter-on-quarter. Year-on-year revenue growth was due to the expanded advertising base boosting ad fill rates in Weixin Moments plus higher CPCs for our Mobile Ad Network. The quarter-on-quarter revenue decline was due to negative seasonality, although QQ KanDian revenue increased sequentially due to traffic growth.

To cater to unmet advertiser demand, in late March, we increased the ad load in Weixin Moments to 2 ads per -- maximum of 2 ads per user day, which remains extremely conservative compared to our global peers. As both our social and feed ad loads are only small fractions of those industry benchmarks, we believe there's a long runway for continued growth in our social and other advertising category.

Digging further into our video business, we believe it sustained rapid growth in operating and financial metrics, reinforcing our industry leadership in the online video market in China where they're measured by mobile DAU or subscriptions. Both daily active users and user time spent on mobile grew strongly year-on-year, and our mobile video views increased over 60% year-on-year.

To recap. Total video revenue, including advertising and subscriptions, was up 75% year-on-year. [indiscernible] video subscription revenue grew 85% year-on-year and our advertising revenue grew 64% year-on-year. Our original content initiatives enjoyed prudent success across multiple verticals.

To call out a few best in industry examples. Our ongoing idol selection variety show, Produce 101, has become the #1 online variety show measured by average views per episode in China to date. Our original animated series, Land of Warriors, set a new record for Chinese anime in terms of video views per episode. We have a rich catalog and a rich pipeline of proven IPs, including The King's Avatar and Battle Through the Heavens. We actively managed the content creation and production of a movie, Forever Young, which has become a box office hit.

And with that, I'll pass to John to go through the financials.

[Shek Hon Lo, executive]

Thank you, James. Hello, everyone.

For the first quarter of 2018, our total revenue was RMB 73.5 billion, up 48% year-on-year or 11% quarter-on-quarter. Comps increased by 51% to RMB 36.5 billion for the first quarter on a year-on-year basis. The increase primarily reflected greater channel cost, cost of payment-related services as well as content costs.

Gross profit was RMB 37 billion, up 46% year-on-year or 18% quarter-on-quarter.

Net other gains were RMB 7.6 billion for the first quarter. Mini represented non-GAAP adjustment in relation to gains and losses from the investees of RMB 7.8 billion, which comprised fair value gains as a result of increasing valuation of certain investments in verticals such as video clip sharing, news feeds, online games and video content creation as well as disposal -- or disposal gains arising from the capital activities of -- from certain investee companies.

Share of losses of associates and joint ventures was RMB 319 million in the quarter versus that of RMB 120 million for the fourth quarter of 2017. On a non-GAAP basis, share of losses of associates and joint venture was RMB 98 million for the first quarter compared to profit of RMB 495 million for the fourth quarter of 2017.

Income tax expense was approximately RMB 5.7 billion, up 57% year-on-year or 84% quarter-on-quarter. The year-on-year increase was mainly due to greater withholding tax forwarded and higher profit before income tax. The Q-on-Q increase was primarily due to the absence of a reversal of income tax expense for certain subsidiaries in China, which were confirmed to enjoy a lower tax rate in the fourth quarter of 2017, as well as greater withholding tax.

The effective tax rate in the period was 19.3%.

Net profit to shareholders was RMB 23.3 billion, up 61% year-on-year or 12% quarter-on-quarter.

I will walk you through our non-GAAP financial numbers. For the first quarter and after adjustments in non-GAAP, operating profit for the quarter was RMB 25.3 billion, up 36% year-on-year or 16% quarter-on-quarter. Operating margin was 34.4%, down 3 percentage points year-on-year or up 1.5 percentage points quarter-on-quarter.

Net profit to shareholders was RMB 18.3 billion, up 29% year-on-year or 5% quarter-on-quarter. Net margin was 26%, down 3 percentage points year-on-year and 1.7 percentage points quarter-on-quarter.

Let's turn to segment gross margin. Gross margin for VAS was 63.3%, up 2.4 percentage points year-on-year or 4 percentage points quarter-on-quarter. The year-on-year increase was mainly driven by higher gross margin achieved for video and music subscription businesses as a result of operating leverage effects. The quarter-on-quarter increase was mainly due to the same reason, as well as higher gross margin for smartphone games business as a result of higher proportion of self-developed games.

Gross margin for online advertising was 31.2%, down 3.6 percentage points year-on-year or 6 percentage points quarter-on-quarter. The year-on-year decrease was mainly due to higher traffic acquisition costs of ad network. The weak seasonality in the first quarter lead to decrease in revenue, impacting the margin in the quarter.

Gross margin for others was 25.4%, up 3.5 percentage points year-on-year and 2.6 percentage points sequentially. This gross margin improvement was mainly driven by the policy of charging service fee for users' credit card prepayment December 2017.

Moving on to operating expenses. Selling and marketing expenses were RMB 5.6 billion, up 76% year-on-year or down 8% quarter-on-quarter. The year-on-year increase mainly reflected greater marketing spending on products and platforms such as payment-related services, platform games and news feed apps. The sequential decrease was mainly driven by seasonally less advertising activities in the first quarter of the year. As a percentage of revenue, S&M expenses decreased to 7.6% for this quarter from 9.1% in the fourth quarter of 2017.

G&A expenses including R&D were RMB 4.4 billion, up 30% year-on-year or up 10% quarter-on-quarter. Under G&A, research and development expenses grew RMB 5 billion, up 39% year-on-year or 5% quarter-on-quarter. Both quarter-on-quarter and year-on-year increases were mainly due to greater staff costs and R&D expenses. As a percentage of revenue, total G&A was 4.8%, and R&D was 6.8%.

At the end of the first quarter, we had about 46,000 employees, which represented an increase of 17% in the area of cloud and online game businesses.

Let's go through margin ratios for the first quarter. Gross margin dipped 0.9 percentage point year-on-year to 50.4%, mainly due to increasing contribution from others segment which carried lower margin. Gross margin was up 3 percentage points sequentially, which was driven by higher VAS segment gross margin.

Non-GAAP operating margin was 34.4%, down 3 percentage points year-on-year, primarily reflecting lower gross margin, reduced dividend income and increasing selling and marketing expenses. Quarter-on-quarter change was up 1.5 percentage points driven by higher gross margin less selling and marketing spending, which was partially offset by lower dividend income.

Non-GAAP net margin was 26%, down 3 percentage points year-on-year mainly due to lower operating margin. Non-GAAP net margin was down 1.7 percentage points quarter-on-quarter, mainly due to higher income tax expense which was partially offset by higher operating margin.

Finally, let me share with you some financial metrics before wrapping up this presentation. Total CapEx was RMB 6.3 billion, up 200% year-on-year or 27% quarter-on-quarter. Operating CapEx was RMB 3.9 billion, increased by 126% year-on-year mainly due to the increased number of servers for expanded businesses, particularly cloud businesses. Nonoperating CapEx was RMB 2.4 billion, up over 5x on a yearly basis mainly due to the direction of spending on land use rights in Beijing in the first quarter of 2018.

Free cash flow was RMB 13 billion, down 46% year-on-year and quarter-on-quarter. The sequential decrease mainly reflected decline in operating cash flow due to payments of year-end bonuses, timing of payments of certain expenditures arising from our payment-related services and tax expenses as well as payment of land use rights.

At the end of March, our net debt position was RMB 14.5 billion compared to net cash of RMB 16.3 billion at the end of 2017.

While our cash flow from operation remained solid, the change to a net debt position, which resulted from higher notes payable, was mainly due to increased strategic M&A investments.

The fair value of our listed companies, excluding subsidiaries, of course, were approximately RMB 213 billion or USD 33.9 billion as at the end of the quarter compared with RMB 211 billion as at 2017 year-end.

Thank you. We shall open the floor for questions.

[Jane Yip, executive]

Operator, we will take one question from each participant. May we have the first question, please?

[Operator]

The first question comes from the line of Grace Chen from Morgan Stanley.

[Grace Chen, analyst]

Question is about your gaming business. We know Tencent already dominated the gaming market in China. So we are interested in understanding your strategy for the overseas expansion. In terms of the game distribution overseas, would you distribute by yourself? Or would you rely on overseas partners to do the distribution? And how would you manage dynamics with the overseas partners? And the follow-up question is about eSports. How would you capitalize on the opportunities from eSports for Tencent in China and overseas markets, especially Tencent has the top game IPs various for eSports?

[James Mitchell, executive]

Okay. I think, Grace, as far as publishing our games internationally, in the past we took the view that the games we developed in China that were suitable for the China market might not be suitable for the rest of the world due to different cultures and behaviors. What we have seen in the past 2 years is that there's some evidence now that in the games created in China can enjoy global resonance, and I'm thinking particularly about the success of stimulating Battlefield game, which has enjoyed a very strong download activity, very positive player reception since we launched it in the Western world a couple of months ago and launched it in Japan today actually. Also, the success of our arena battle game, which is a battle arena game based on Honor of Kings, which has built up a large and loyal user base in Western markets. So I think what you're seeing is that we are focusing on this opportunity more going forward. In terms of your question around whether we publish ourselves or rely on partners, the answer varies, to some extent, depending on geography. So for example, in Southeast Asia, as you may know, our affiliate company, Sea Corporation or Garena, publishes some of our games successfully. And the answer would also depend to some extent on the nature of the game. So we're in the process of iterating and finding out the best solution, but we're very happy with arena and we're stimulating Battlefield in particular, and we've been very happy with some of our local publishing partners such as Sea Corporation. With regard to eSports, you're correct to observe that some of our games, particularly League of Legends, have become very widely watched eSports in their own right. Up until this point in time, our focus is still largely on utilizing eSports as a way of boosting engagement among existing users of the game and also, to some extent, driving interest among new players of these games. We are aware that there should be -- that there could be and there should be substantial monetization opportunities around eSports and we've made some experiments in that direction with League of Legends, in particular. But in general, our philosophy is still to use eSports primarily as a way of rewarding the players of these games, restimulating interest among lapsed players of the games and stimulating interest among new players of the games.

[Operator]

The next question comes from the line of Alex Yao from JPMorgan.

[Alex Yao, analyst]

I have a follow-up question on the gaming business. On the PC side, we understand last year first quarter base was a bit tough, and you delivered a flat PC gaming revenue this quarter. How do you think about monetization outlook for PC gaming for the rest of the year? And then on the mobile gaming side, while you drive gamer growth through the tactical tournament games, what's the monetization strategy before you monetize those at large DAU games? And also what's holding you back in monetizing the mobile survival shooting game?

[Chi Ping Lau, executive]

I think on the PC game revenue, as we have repeatedly saying, there is a shift in terms of user time from PC to mobile. So I think there is a seasonal boost in terms of our PC revenue in the first quarter. But I think if you look into the future, I would say the shift of the user time from PC, that revenue will be probably under pressure because of this issue. Now in terms of the tactical tournament game, I think we're very happy to report that we have really nailed this genre, which is probably the biggest opportunity after the mobile opportunity in the gaming industry in the past -- in 5 years. And we have gained a lot of user base both through our self-developed mobile game in cooperation with our partner as well as through our large strategic investment in Epic. Now in terms of the mobile game that's operating in China, it's pending regulatory approval for monetization. So there is going to be an uncertain amount of time before we can start monetizing. Now we do believe this is a matter of when, so we are working very hard to try to get the regulatory approval. But for the moment right, since it's not monetizing and it's a very big DAU, we -- the financial results will have to wait. But as it comes to tactical tournament as a genre, we believe that what Fortnite has done is a good example. Through seasonal passes and a number of different item monetization, Epic has been able to achieve quite satisfactory monetization in that game genre. And we believe when the time comes when we can actually monetize, there should be pretty significant opportunity around monetization.

[Operator]

Next question comes from the line of Karen Chan from Jefferies.

[Karen Chan, analyst]

So just a follow-up on the games since we have already started preregistration for Fortnite in China. So do we have any target timeline on that? And also my second question would be we noticed that there has been recent rollout of new app formats within Mini Game, like short video app. Any update on monetization progress so far? And how big of a monetization potential should we be expecting from Mini Game on both advertising and in-game ads and purchase?

[Chi Ping Lau, executive]

In terms of Fortnite, we have indeed started preregistration and we're in process of getting approval of the game for launch in China. The timing is not completely set yet. So I think you have to wait for the next announcement to ascertain the time for the launch. Now with respect to monetization on Mini Games, I think we are testing the water in terms of monetizing the Mini Games. And over time, I think we do want to create an ecosystem in which the app developers -- the Mini Game developers can actually generate revenue, right, so that ecosystem would become prosperous. So we would more look at this as an opportunity for us to make sure that the Mini Games ecosystem is strong and vibrant. It is going to create some revenue for us, but I think a lot of the revenue opportunity we do want to make sure that it's for the ecosystem itself. Now in terms of the item sales, at this point in time, it's only opened in a limited extent on Android. So I think, again, it's more of a testing of the monetization systems so that we can generate some revenue for the Mini Games developers.

[Operator]

The next question comes from the line of Piyush Mubayi from Goldman Sachs.

[Piyush Mubayi, analyst]

How should we think of the range of monetizations of the PC games we've seen in the overall number that we saw reported for the first quarter? And I mean the range being Dungeon & Fighter's number versus what the rest of the universe implies. If you could just shed some color on that, it would be great.

[James Mitchell, executive]

Piyush, can you rephrase the question perhaps, just so we're clear what you're asking.

[Piyush Mubayi, analyst]

So it appears through Nexon's filings that Dungeon Fighter did well in the first quarter. And if you take that revenue line out of your PC revenue reported for the quarter, it appears that the rest of the PC portfolio you have has done -- rather has not performed as well. So how would you explain the range of performances between these 2 sets of games?

[James Mitchell, executive]

Well, I think that there's a few verticals to think about when you're drawing that comparison. The Dungeon & Fighter is an incredibly important game for us and we're very pleased with its ongoing success. But one variable is that typically the developer of a game will report revenue on a sort of cash in that quarter basis versus we will defer the cash in that quarter over the amortization period. So there may be a time lag between spikes in revenue that a developer reports versus spikes in revenue that a publisher reports. A second factor is that there are some specific PC games where we have a catalog of virtual items. And at times we put that catalog to work more aggressively and other times we seek to restock that catalog. And for some of our PC games, we're in the restocking process this year. And then, thirdly, as Martin mentioned, the PC game industry as a whole is under pressure in China because of the increasing quality of mobile games. Now it is very gratifying to us that Dungeon & Fighter is doing so well and it's particularly gratifying to us that it's doing so well in its 10th year of life. But in the other games, there can be more revenue volatility because of that headwind from users playing mobile games.

[Operator]

The next question comes from line of Eddie Leung from Merrill Lynch.

[Eddie Leung, analyst]

I have a question on the competitive environment about mobile news. So how do you think about your positioning in the segment right now versus a year ago, given certain changes in some of the apps? And how would you think about the industry structure in the future? Will it be content [ related ] or fragmented? Any insight would be helpful. And may I just have a quick follow-up on the operating cash flow. Could you share a little bit more color about the year-on-year decline in the operating cash flow? You mentioned a couple of factors. So just wondering which ones would be the most important ones.

[Chi Ping Lau, executive]

Eddie, I think what you meant is really the news feed industry. And I would say the news feed industry had actually sort of experienced a lot of new developments in the past year. I think broadly speaking, when we started, before the news feeds come into play, right, there was the news app and there's also Official Accounts which is within WeChat and both of them were very vibrant and -- especially the Official Accounts, it actually gave rise to a large number of self-media, which then the news feed industry actually took. And by providing machine learning capability and providing customized feed, it's a more efficient way of providing content to users. And that news feed industry started with text and photo and that's the content format. Now if you look at in the past year, I think the text and photo format has really reached a peak in terms of daily users and engagement. And then there's a new format coming out, which is short video, and that has captured quite a bit of user time. And then another media format actually came around, which is the mini video, right. Short video is a content format in which it ranges from 1 to 5 minutes whereas a mini video is a vertical video format, which usually it's 15 to 30 seconds. And that's where we stand in terms of sort of the evolution of the entire industry. Now if you look at Tencent, I think in news, itself, right, as a media, we continue to lead the industry with our news app, with our WeChat and QQ plug-in. Our Official Accounts continues to generate a lot of page views every day. Now in terms -- but we also recognize the importance of having a news feed, which can actually provide information and all sorts of different media content to users on a customized basis. So that's why we have been curating our own news feeds within our different social and media platforms, and most notably, we have done it very successfully through KanDian. And as you know we have disclosed in the prepared remarks our KanDian DAU is already in the 80 million DAU category and has grown very strongly from last year. And in addition to the distribution platform, we're also working on the multiple media format front. And we have started to provide much more short video through our news feed, be it in KanDian or mobile browser or in our top stories within WeChat as well as on news apps, Kuai Bao. And at the same time, we have just relaunched our mini video platform, WeiShi, and I think the mission of WeiShi is really to provide short -- mini video, this format content to the different distribution platforms within our own social apps and browser apps. And I think as we have said, WeiShi, we believe it has the advantage of in addition to get the PUGC content in the market, we can also get access to our long video and music and sports and variety show. We have a lot of very exclusive content that can be reformatted into mini video format. And at the same time for WeiShi, it's not just for its own distribution. It will be distributed across all our different news feed platforms. So we will be putting quite a bit of investment into WeiShi and we feel pretty good about its prospect over time.

[Shek Hon Lo, executive]

In terms of the operating cash flow, if we compared year-on-year basis, the bigger impact would be the payment-related type of thing followed by the tax as well as the year-end bonuses. I'll explain a little bit here. In terms of the payment fees in relation to pay -- the fees in relation to payments, the reason for having such a big amount of payment this quarter was because usually we accrued all this on a monthly basis while the payment from time to time it might be different. In some years, it might be end of the year. And in some years, it might be the first quarter. So there's a bit of deferral in payment this year. That's why we see a dip in the operating cash flow in relation to this. And for the tax, usually, we -- of course, we accrued on a monthly basis and we pay some of the provisional tax during the year. And usually after the closing of year, there will be a larger payment that will take place in quarter 1 and this impacts the operating cash flow for this quarter. Of course for the bonus payments, as you see, we have more people this year versus last year and the total staff costs actually increased by 29% year-on-year. So it is quite natural that it will increase year-over-year.

[Operator]

The next question comes from the line of Alicia Yap from Citi.

[Alicis a Yap, analyst]

I have a question related to the overall Mini Program ecosystem. We are increasingly hearing from various of your partners regarding helping their brands or their merchants on their existing platforms to set up Mini Program or Official Accounts within the WeChat ecosystem. Should we be worried that there could be too crowded among brands and retail eventually? Are there any checks and balances that the company will be putting in place to ensure the user experience balance is well in control? And for that part, in addition to payment settlement fee income and maybe potentially some advertising revenue, what could be other potential monetization opportunities from those retail Official Accounts?

[Chi Ping Lau, executive]

Well, I think in terms of Mini Programs, I think the original design mission is actually for the Mini Programs to be very light. It's very easily discoverable by users. It can be invoked very easily, used very easily. And then once it's -- the usage is done, it disappears, right? So I think that's the design philosophy. And as a result, you can see, right, we have not provided a long-term position for the Mini Programs that you have used, right? We try to hide it from the user interface. But in order to provide an easy access, we do have this -- put our manual for recently used Mini Programs. So I think it should not suffer from the problem of overcrowded-ness. And especially we are trying to enable each one of the Mini Programs to have its own way to reach its customers, and I think the most natural way for Mini Program to really spread is, one, the provider has got these access paths with the users; and two is through social recommendation, and we believe that it will be the most natural way for Mini Programs to be spread across the social network. Now in terms of the monetization, I think at this point in time we're thinking less about monetizing Mini Programs directly. We're more thinking about how do we enable the ecosystem to grow stronger over time. And we believe that if the Mini Program ecosystem really grows strongly, then a lot of our existing monetization models will be -- will benefit, right? For example, payment will benefit. For example, our advertising system will actually benefit. And as a result, we felt that's a more natural way for us to benefit our other existing businesses and also our cloud business will also benefit as a result of Mini Programs proliferating. Finally, we also felt that Mini Program is a very good and synergistic way for us to promote apps. If you look at Mini Games, right, we believe that Mini Games will help to promote the discovery as well as the download of a lot of heavier native app games. And in addition, as I said earlier, we believe that a lot of companies and developers who otherwise will not be developing a standalone native app will now be able to develop a very light Mini Program first, and if we can get enough users, then they will move on to developing the native app which we believe is also a good way for us to enrich our overall ecosystem.

[Operator]

The next question comes from the line of Wendy Huang from Macquarie.

[Wendy Huang, analyst]

Just a few quick questions. So firstly, is on the payment. So this quarter, payment achieved a triple-digit growth and also the gross margin record high, 25%. With all the regulations actually effective April 1 and also the competition from Alipay heating up, how should we expect the revenue momentum with the margin trend for the August 1 [indiscernible] payment now? And also on the e-commerce front, currently you're having lots of new retail partners. For example, in WeChat Wallet, you're having both Noguchi and Vipshop. So what's your different strategies or approach when you're dealing with the different partners in these same areas?

[Chi Ping Lau, executive]

I think in terms of payment right now, we are pretty pleased to see that there is an increased adoption of our payment solution in the off-line world. And we do believe that our market share has been quite substantial and sustained. Now in terms of the competition, yes, it's a fact -- a matter of fact that the competition is actually very heavy and there have been a lot of subsidies provided in the market by our market peers, and as a result, we actually have to follow suit. So we are -- we are already spending quite of bit of money in terms of subsidy, and a part of it affects our overall take rate and part of it is actually in the promotional expenses within our financials. So we do believe this level of subsidy will continue in the near-term future because it is indeed a very big opportunity and we expect our -- all industry participants to investing heavily in this market. But on the other hand, we also believe the fact that there is a lot of subsidies and promotional expenses to help expand the market, which benefits everybody. And at the same time, we believe that because of our unique positioning within social payment and within convenience for users, we have a pretty distinctive advantage in the market. Now in terms of e-commerce partners, right, we do offer entry points in our wallet to different e-commerce partners. I think each one of these e-commerce partners have got their pretty distinctive positioning of the merchandise they produce as well as the way they market their products. And so what we are doing is really sort of providing the entry point and be an enabler. We will help them to make their distinctive feature more distinctive. And if there is a word-of-mouth effect that can be generated from their distinctive position and their merchandise, our social network helps to magnify that word-of-mouth effect.

[Operator]

The next question comes from the line of Gregory Zhao from Barclays.

[Gregory Zhao, analyst]

So my question's a follow-up question about the user time spent, so just a large picture question about the industry. So why are we seeing retail Weixin, QQ, Honor of Kings and some other of your flagship apps are taking a lot of user time spent. So we're also seeing a variety of new functions and also competitors in the areas like long video, short video and other entertainment sections. They're also taking some user time spent. So can you help us understand overall the industry dynamics of the user time spend shift, such as how the increasing time spent on gaming and short video may affect each other and as well as the long video and other entertainment functions?

[Chi Ping Lau, executive]

Well, in terms of overall, I feel the amount of time that people spend online has been increasing. Now with respect to specific apps, right, I think you're probably referring to the short video and mini video if I have to take a guess. And I would say with respect to this type of apps, our observation is that, number one, it's mainly a content business. So it doesn't have much impact on our social user activity. And most of this content is actually in the category of PUGC, which straddles between PGC, professionally generated content, and UGC. And as you know, we are traditionally very strong in terms of the PGC as evidenced in our leadership in news, in video, in music and in literature and sports. And I think the PGC actually don't get affected that much. If you look at our video platform as an example, we have mentioned that our video viewers actually grew by 60% year-on-year. So it has been growing in terms of both DAU as well as overall average user -- as time spent per user. So I think my guess is that short video and mini video is actually taking some time from the non-Internet time of users, one; and two, it's getting some time from the more PUGC content platforms.

[Operator]

The next question comes from the line of Jin Yoon from Mizuho.

[Jin Yoon, analyst]

Now that you've invested quite a bit into video content, including short-form video, and revamped the news feed, how should we look at the trajectory of the kind of the news feed going forward in terms of potentially what you're looking in terms of revenues or ad loads, or any color behind your outlook on news feed would be great.

[Chi Ping Lau, executive]

On news feed, it's definitely a strategic, important business for us because we know that this is an efficient way of providing content to users. And very clearly, we have a distribution strategy, which is tying the news feed to our large Internet platforms including our social platform and other content platform. And we also have a content strategy, which is trying to get the best PUGC content within photo and text, within short video and within mini video while at the same time, leveraging our unique access to some of our exclusive content tied in with our long video as well as the PUGC content ecosystem. I think it's actually a long-term strategy of pushing ahead, right? We definitely sort of feel that there's a lot of potential in this area. We continue to make investment in this area. And over time, this would help us to provide better content to our users. This will help us to also generate advertising inventories. At this point in time, the ad load in our existing news feeds is actually relatively low. It's only a fraction of our industry peers. But -- and we'll definitely increase it over time. But I think in line with our -- of our philosophy, whenever there's a product, we want to make sure that the user experience comes first. So we will be ramping up our ad loads on a measured basis. Overall, I think we look at it as a very long-term investment and we'll continue to make progress in this area.

[Operator]

The next question comes from the line of Thomas Chong from Credit Suisse.

[Yiu Hung Chong, analyst]

My first question is about the online video landscape. Given our strong revenue growth in Q1, going forward, do we see any chance for cooperation with other peers? And my second question is about the trend for the deferred revenue, which we see the growth rate is a bit soft in Q1. Just want to see if any reason on that front. And my third question is about the trend for the operating expenses for this year. And finally, I just want to get a sense about...

[James Mitchell, executive]

I think that's probably enough questions, otherwise we won't have time for your colleagues to ask anything. In terms of the online video landscape, so as you're probably aware, we do indeed frequently share content, swap content, co-purchase content with some of the other big online video platforms. That's particularly true for content that is monetized through advertising and particularly true for expensive or high-profile content such as recent movie releases. On the other hand, we are increasingly investing in our proprietary content and I mentioned some of the more successful in-house content such as Produce 101. And that content, which we normally wouldn't share, can be particularly beneficial for driving subscriptions because then the users know that if they want to see that content, they should come to a given platform, and it develops loyalty and payment behavior and engagement with that platform. So that's on the online video front. John, on the revenue?

[Shek Hon Lo, executive]

Yes, in terms of the deferred revenue, I don't think it's really soft given that every quarter, we still have to amortize some of the business cooperation agreement for some of the companies, just JD or whatever, and right now there's an increase of about 8% quarter-over-quarter. So it's quite normal, I would say.

[Operator]

This is the last question, Natalie from CICC.

[Yue Wu, analyst]

My question is regarding the online gaming business. Just wondering how should we think of the future performance of some of your pillar games such as Honor of Kings life span monetization upside, the sustainability of the robust year-on-year growth, et cetera. And also how should we compare the gross profit margin profile between maybe mobile games and licensed PC games.

[James Mitchell, executive]

So in terms -- I apologize because we didn't hear all of the question completely clearly. So if you need to clarify, please do. But I think one part of the question was related to the life span of some of our big games and the second part of the question is related to the gross profit margins of our games. Historically, as you would expect, the games where we license the game code, the software, then gross margins would typically be substantially lower versus games where we create the software and IP in-house. And then the games where we are licensing the IP but create the software in-house, the gross margins would be in between the two, but typically closer to self-developed games. For mobile games versus PC games, there's historically been less gross margin variation than there has for licensed versus self-developed games. During 2017, the gross margins on our mobile game portfolio did experience some downward pressure because we began sharing revenue with selected app store partners in situations where the app store is -- belongs to the handset manufacturer. So that had some impact on our gross margin dynamic. But in general, a self-developed mobile game will still be higher gross margin than a licensed PC game. So I hope that answers the second half of your question. And then in terms of the first half of your question around the life cycle -- or life span of games, the mobile game industry is really too young for anyone to have an informed point of view at this point in time. But it is interesting to note that within mobile games, the top 10 mobile games in the Western world today include many titles such as Candy Crush and Clash of Clans have been top 10 titles for several years now. And if we look at the PC game industry then, as we noted in our prepared remarks, Dungeon & Fighter is now entering its 10th year of life in China and is one of the most successful apps, the most successful PC game in China by revenue. League of Legends has been in the market for many years and remains highly successful. And then globally, games such as Counter-Strike have been kind of evergreen and persistently successful for over a decade. So part of why the game industry is attractive industry is because on the one hand, you have these phenomena that really energize players, bring new players into the industry, create a great deal of popular excitement like Fortnite and the tactical tournament games. But on the other hand, you have games like a Counter-Strike or a League of Legends or a Dungeon & Fighter or Clash of Clans that build up a large and stable user base over a long period of time and appear to sustain and build that user base loyalty over a very long life cycle.

[Jane Yip, executive]

Thank you. We are closing the call now. If you wish to check out our press release and other financial information, please visit the IR section of our company website. The replay of this webcast will also be available soon. Thank you, and see you next quarter.

[Operator]

That does conclude our conference for today. Thank you for participating in Tencent Holdings Limited 2018 First Quarter Results Conference Call. You may all disconnect now.