Hello (MOMO) - 2018 Q4 - Annual Report

Part I Key Information This chapter provides the company's key financial data, capital structure, use of proceeds, and a comprehensive analysis of risk factors, highlighting challenges in user growth, monetization, Tantan integration, VIE structure compliance, and Chinese regulatory changes Selected Financial Data The company achieved significant revenue and profit growth from fiscal year 2016 to 2018, primarily driven by its live video business, and changed its reporting currency from USD to RMB starting in Q4 2018 Consolidated Statements of Operations Summary (2016-2018) | Indicator | 2016 | 2017 | 2018 | | :--- | :--- | :--- | :--- | | Total Net Revenue (RMB thousand) | 3,707,358 | 8,886,390 | 13,408,421 | | Operating Profit (RMB thousand) | 975,093 | 2,434,252 | 3,266,292 | | Net Income Attributable to Momo Inc. (RMB thousand) | 978,969 | 2,148,098 | 2,815,775 | | Diluted Earnings Per Share (RMB) | 2.41 | 5.17 | 6.59 | Net Revenue Breakdown (2016-2018) | Revenue Source | 2016 (RMB thousand) | 2017 (RMB thousand) | 2018 (RMB thousand) | | :--- | :--- | :--- | :--- | | Live Video Service | 2,534,604 | 7,429,906 | 10,709,491 | | Value-Added Service | 449,781 | 695,798 | 1,883,150 | | Mobile Marketing | 441,644 | 514,279 | 500,321 | | Mobile Games | 236,238 | 241,388 | 130,392 | | Other Services | 45,091 | 5,019 | 185,067 | Consolidated Balance Sheets Summary | Indicator | December 31, 2017 (RMB thousand) | December 31, 2018 (RMB thousand) | | :--- | :--- | :--- | | Total Assets | 8,471,188 | 18,965,538 | | Total Liabilities | 1,719,088 | 7,942,679 | | Total Equity | 6,752,100 | 11,022,859 | - Effective Q4 2018, the company changed its reporting currency from USD to RMB to better align with industry peers, with prior financial statements restated to reflect this change[16] Risk Factors The company faces significant risks across multiple dimensions, including business and industry challenges, corporate structure vulnerabilities, operational complexities in China, and ADS-related market fluctuations - Business and Industry Risks: - User Growth and Engagement: User base and engagement are critical, and failure to retain existing users or attract new ones will materially and adversely affect the business - Monetization Uncertainty: Current business models, especially live streaming, are not proven sustainable, and new services may not be profitable - Reliance on Live Streaming: Live video services accounted for 79.9% of net revenue in 2018, and the growth and profitability of this business face challenges[25] - Tantan Acquisition and Integration: The acquisition of Tantan in May 2018 presents challenges in user retention, operational integration, and synergy realization, potentially impacting financial performance[34] - Content Regulation: Content on the platform, including live streams, may be deemed non-compliant by Chinese regulators, leading to severe penalties such as fines or license revocation[31] - Market Competition: The social and live streaming industries are highly competitive, and competitors may possess greater resources[46] - Corporate Structure Risks: - VIE Structure Risks: Operating through a VIE structure in China, the company may face severe penalties or be forced to abandon related interests if the Chinese government deems the structure non-compliant[85] - Effectiveness of Contractual Arrangements: Reliance on contractual arrangements with VIEs and their shareholders to control operations may be less effective than direct ownership and subject to enforcement uncertainties under Chinese law[88][90] - Risks Related to Doing Business in China: - Legal and Regulatory Uncertainty: Interpretation and enforcement of Chinese laws and regulations are uncertain, potentially limiting the company's legal protection[99] - Licenses and Approvals: Business operations require obtaining and maintaining various government licenses (e.g., ICP, online culture operating permits), and failure to do so or renew them will affect the business[102] - Tax Risks: The company may be deemed a Chinese "resident enterprise," leading to a 25% enterprise income tax on global income and potential withholding tax on dividends and capital gains for non-Chinese shareholders[108] - Risks Related to ADS: - Share Price Volatility: ADS trading prices may fluctuate significantly due to company performance, market sentiment, analyst reports, and other factors[145] - Concentration of Control: The dual-class share structure grants Mr. Yan Tang, founder and CEO, 70.9% of the total voting power as of March 31, 2019, allowing him to exert decisive influence over major company matters[153] - Foreign Private Issuer Status: As a foreign private issuer, the company is exempt from certain information disclosure and corporate governance requirements applicable to domestic U.S. companies, such as filing 10-Q quarterly reports and proxy rules[165] Information on the Company This chapter outlines the company's history, business overview, organizational structure, and key assets, detailing its operation of "Momo" and "Tantan" mobile social platforms through a VIE structure and its asset base History and Development of the Company The company began operations in 2011, listed on Nasdaq in 2014, and expanded significantly with the acquisition of Tantan and the issuance of convertible senior notes in 2018 - The company began operations in 2011 and was listed on Nasdaq in December 2014 under the ticker symbol "MOMO"[176][178] - In May 2018, the company completed the acquisition of Tantan, a Chinese social and dating application, for a total consideration of approximately 5.3 million newly issued Class A ordinary shares and US$613.2 million in cash[34][176] - In July 2018, the company issued US$725 million in aggregate principal amount of 1.25% convertible senior notes due 2025[178] Business Overview The company operates "Momo" and "Tantan," leading mobile social and dating platforms in China, with live streaming as its primary revenue driver, supported by a dedicated content management team - The company operates two core platforms: Momo, a comprehensive social entertainment platform, and Tantan, focused on social networking and dating for young users[179] Momo Platform Monthly Active Users (MAU) | Year | MAU (million) | | :--- | :--- | | December 2016 | 81.1 | | December 2017 | 99.1 | | December 2018 | 113.3 | 2018 Revenue Composition | Service Category | Percentage of Total Net Revenue | | :--- | :--- | | Live Video Service | 79.9% | | Value-Added Service | 14.0% | | Mobile Marketing Service | 3.7% | | Mobile Games | 1.0% | | Other Services | 1.4% | - The company generates most of its revenue through live streaming services, where users purchase virtual gifts for broadcasters, and the company shares revenue with broadcasters or their talent agencies[201] - Value-added services include Momo and Tantan membership subscriptions and virtual gift services on the Momo platform, with Tantan's paid features including VIP membership, "See Who Likes Me," and "Super Exposure"[199][203] - The company places high importance on content management, with a dedicated team of over 1,126 employees across Momo and Tantan as of the reporting date, responsible for reviewing and processing platform content to ensure compliance[216] Organizational Structure The company, a Cayman Islands-registered holding entity, primarily conducts its China operations through Variable Interest Entities (VIEs) and their subsidiaries, controlled via a series of contractual arrangements to navigate foreign ownership restrictions - Due to Chinese legal restrictions on foreign investment in industries like value-added telecommunications services, the company primarily conducts its business in China through its VIEs, such as Beijing Momo Technology Co., Ltd., and their subsidiaries[304] - The company controls its VIEs through a series of contractual arrangements with the VIEs and their shareholders, granting the company effective control, the right to receive substantially all economic benefits, and an option to purchase VIE equity when legally permissible[305] - Key contractual arrangements include: - Business Operations Agreement: Controls major operational decisions of the VIE - Exclusive Cooperation Agreement: Transfers VIE profits to the company's wholly-owned subsidiary as service fees - Equity Pledge Agreement: Pledges VIE shareholders' equity to the company's wholly-owned subsidiary to secure performance of contractual obligations - Exclusive Call Option Agreement: Grants the company the right to purchase VIE equity at a nominal price or the lowest price permitted by law - Power of Attorney: VIE shareholders irrevocably grant their voting rights to the company's wholly-owned subsidiary[308][310][311][312][314] Property, Plant and Equipment The company's headquarters and primary service development facilities are located in Beijing, with additional leased office spaces globally and servers primarily hosted in third-party data centers - As of March 31, 2019, the company leased approximately 38,729 square meters of office space across Beijing, Chengdu, Tianjin, Shanghai, Guangzhou, Kuala Lumpur, and San Jose, with lease terms ranging from seven months to five years[318] - The company's servers used for providing services are primarily hosted in multiple third-party internet data centers in Beijing[318] Operating and Financial Review and Prospects This chapter analyzes the company's operating performance, liquidity, capital resources, R&D activities, and contractual obligations, highlighting continued revenue growth driven by live streaming and value-added services, healthy cash flow, and ongoing investment in R&D Operating Results The company's net revenue increased by 51% to RMB 13.408 billion in 2018, primarily driven by strong growth in live streaming and value-added services, while total costs and expenses also rose significantly, leading to a 30% increase in net income 2018 vs. 2017 Revenue Comparison (RMB million) | Revenue Category | 2017 | 2018 | Year-over-Year Growth | | :--- | :--- | :--- | :--- | | Live Video Service | 7,429.9 | 10,709.5 | 44.1% | | Value-Added Service | 695.8 | 1,883.2 | 170.6% | | Mobile Marketing | 514.3 | 500.3 | -2.7% | | Mobile Games | 241.4 | 130.4 | -46.0% | | Total Net Revenue | 8,886.4 | 13,408.4 | 50.9% | - Total costs and expenses in 2018 were RMB 10.396 billion, a significant increase from RMB 6.609 billion in 2017, primarily due to: - Increased revenue sharing with the growth of live streaming and virtual gift revenue - Higher production costs related to TV content - Increased compensation and benefits expenses due to a larger R&D workforce[335][353][356] - In 2018, the company reorganized its operating segments into three: Momo, Tantan, and QOOL, with Momo segment revenue at RMB 12.812 billion, Tantan segment revenue at RMB 418 million, and QOOL segment revenue at RMB 178 million[334][366][367] - Key factors influencing operating performance include user growth, user engagement, monetization capabilities, and investments in technology and talent[322][323][324][325] Liquidity and Capital Resources As of year-end 2018, the company held RMB 2.468 billion in cash and equivalents, primarily funded by operating cash flow and financing activities, with sufficient liquidity for the next 12 months, though dividend transfers from Chinese subsidiaries are subject to regulatory restrictions Cash Flow Statement Summary (RMB thousand) | Item | 2016 | 2017 | 2018 | | :--- | :--- | :--- | :--- | | Net Cash Provided by Operating Activities | 1,466,290 | 2,886,107 | 3,327,718 | | Net Cash Used in Investing Activities | (800,919) | (188,174) | (10,034,004) | | Net Cash Provided by Financing Activities | 124 | 2,833 | 4,687,951 | | Cash and Cash Equivalents, End of Period | 1,788,268 | 4,462,194 | 2,468,034 | - The significant outflow of cash from investing activities in 2018 was primarily due to purchases of time deposits and short-term investments, payments for the Tantan acquisition, and purchases of servers and other equipment[444] - The substantial inflow of cash from financing activities in 2018 was mainly due to the issuance of convertible notes and obtaining bank loans[447] - As a holding company, the company relies on dividends from its Chinese subsidiaries to meet cash needs, but Chinese regulations restrict dividend transfers from subsidiaries to the offshore parent; as of December 31, 2018, restricted net assets (including registered capital and statutory reserves) amounted to RMB 1.477 billion[435][436][449] - In March 2019, the company declared a special cash dividend of US$0.62 per ADS, totaling approximately US$128 million, to be paid from surplus cash on the balance sheet[440] Research and Development The company's R&D efforts focus on continuous platform enhancement and game development, with a large team of engineers and developers comprising approximately 55% of its total workforce, driving a consistent increase in R&D expenditures - The R&D team is the company's largest, with engineers and developers accounting for approximately 55% of the total workforce as of year-end 2018[451] Research and Development Expenses (2016-2018) | Year | R&D Expenses (RMB million) | Percentage of Total Revenue | | :--- | :--- | :--- | | 2016 | 208.6 | 5.6% | | 2017 | 346.1 | 3.9% | | 2018 | 760.6 | 5.7% | - The increase in R&D expenses is primarily due to higher compensation and benefits for R&D personnel, and the company expects to continue expanding its R&D team to develop new features and enhance big data analytics capabilities[452] Contractual Obligations As of December 31, 2018, the company's primary future contractual obligations include RMB 217 million in non-cancelable operating lease commitments and RMB 47.5 million in long-term investment subscription commitments Future Minimum Operating Lease Commitments (as of December 31, 2018) | Period | Amount (RMB thousand) | | :--- | :--- | | 2019 | 99,133 | | 2020 | 82,697 | | 2021 | 26,980 | | 2022 and thereafter | 8,633 | | Total | 217,443 | - As of December 31, 2018, the company had an obligation to pay RMB 47.5 million for equity subscriptions in long-term investees[456] Directors, Senior Management and Employees This chapter provides key information on the company's governance and human resources, including executive and director compensation, equity incentive plans, board composition, committee responsibilities, and employee demographics Compensation In fiscal year 2018, the company paid approximately RMB 114.8 million in cash compensation to executives and RMB 0.6 million to non-executive directors, utilizing various equity incentive plans as a significant component of its compensation strategy - In fiscal year 2018, the company paid approximately RMB 114.8 million (US$16.7 million) in total cash compensation to its executive officers and RMB 0.6 million (US$0.09 million) to its non-executive directors[471] - The company has implemented several equity incentive plans, including: - 2012 Plan: No new awards are granted under this plan - 2014 Plan: The primary current incentive plan, with 23,462,705 options and 440,001 restricted share units (RSUs) granted as of March 31, 2019 - Tantan Plans: Including the 2015 and 2018 plans, used to incentivize Tantan employees[472][482][493][495] Granted and Unexercised Awards Under 2014 Plan (as of March 31, 2019) | Award Type | Granted (units) | Unexercised (units) | | :--- | :--- | :--- | | Options | 23,462,705 | 15,404,425 | | Restricted Share Units (RSU) | 440,001 | 187,500 | Board Practices The company's board of directors consists of seven members and operates with three independent committees—Audit, Compensation, and Nominating and Corporate Governance—each composed of independent directors responsible for oversight of financial reporting, executive compensation, and director nominations - The board of directors consists of seven directors and has three committees: the Audit Committee, the Compensation Committee, and the Nominating and Corporate Governance Committee[501][502] - The Audit Committee comprises Benson Bing Chung Tam, Dave Daqing Qi, and Yong Li, all meeting independence requirements, with Mr. Tam and Dr. Qi identified as "audit committee financial experts"[503] - Both the Compensation Committee and the Nominating and Corporate Governance Committee are composed of Yong Li, Benson Bing Chung Tam, and Dave Daqing Qi, all of whom meet independence requirements[504][506] Employees As of December 31, 2018, the company's total workforce significantly increased to 2,147 employees, with R&D personnel constituting the largest functional group, complemented by 960 contract workers primarily for content management and customer service Employee Count and Composition (as of December 31, 2018) | Function | Number of Employees | | :--- | :--- | | Research and Development | 1,172 | | Customer Service, Sales and Marketing | 403 | | Operations and Cost | 317 | | General and Administrative | 255 | | Total | 2,147 | - In addition to full-time employees, as of year-end 2018, the company utilized 960 contract workers through labor dispatch agencies, primarily for content management and customer service roles[512] Major Shareholders and Related Party Transactions This chapter details the company's major shareholder structure, revealing founder Yan Tang's absolute control through a dual-class share structure, and outlines significant related party transactions, including contractual arrangements with VIEs and business dealings with Alibaba-affiliated entities Major Shareholders As of March 31, 2019, founder, Chairman, and CEO Yan Tang is the controlling shareholder, holding 20.8% of the company's shares and 70.9% of the total voting power through a dual-class share structure, granting him effective control - As of March 31, 2019, founder, Chairman, and CEO Yan Tang beneficially owned 20.8% of the company's shares but controlled 70.9% of the total voting power through Class B shares (10 votes per share), establishing effective control over the company[153][520] - The company employs a dual-class share structure, where Class A ordinary shares have one vote per share, and Class B ordinary shares have ten votes per share, with Class B shares convertible to Class A shares on a 1:1 basis at any time[520][524] - As of March 31, 2019, the company had 334,334,074 Class A ordinary shares and 80,364,466 Class B ordinary shares issued and outstanding[517] Related Party Transactions The company's operations are fundamentally reliant on contractual arrangements with its VIE entities and their shareholders, alongside significant historical and ongoing business transactions with Alibaba-affiliated companies and other investees - The company's core operations rely on a series of contractual arrangements with its VIEs (e.g., Beijing Momo Technology) and their shareholders[526] - In 2016 and 2017, the company had significant business dealings with Alibaba-affiliated companies (e.g., Alimama, Alibaba Cloud, Taobao), including providing mobile marketing services and procuring cloud computing services[529][531] - The company paid RMB 429.3 million in 2018 for revenue sharing from live streaming and other services to Hunan Qindao Culture Communication Co., Ltd. and its subsidiaries, in which the company holds a 26.4% equity interest[533] - Pursuant to shareholder agreements, the company granted certain shareholders securities registration rights, including demand registration rights, Form F-3 registration rights, and piggyback registration rights[535][536][537][539] Financial Information This chapter presents the company's consolidated financial statements and other financial disclosures, including ongoing legal proceedings related to copyright and patent infringement, and details its dividend policy, which includes a recently declared special cash dividend but no fixed future payout plan Consolidated Statements and Other Financial Information The company is involved in ongoing legal proceedings, including a copyright infringement case for the game "Xiaoyao Xiyou" with a final judgment of RMB 4 million in compensation, and four patent infringement lawsuits totaling approximately RMB 4 million in claims, while also announcing a special cash dividend of US$0.62 per ADS in March 2019 without a fixed future dividend policy - The company is involved in a copyright infringement lawsuit concerning the game "Xiaoyao Xiyou," with a final judgment requiring the company to pay RMB 4 million in compensation, which was paid in October 2018, though the plaintiff has applied for a retrial[543] - In February 2019, the company received four civil lawsuits alleging infringement of four patents, with total claims of approximately RMB 4 million, and the cases have not yet proceeded to trial[543] - The company announced a special cash dividend of US$0.62 per ADS in March 2019, totaling approximately US$128 million, but it does not have a fixed dividend policy and future dividends are uncertain[545] Additional Information This chapter primarily addresses tax implications related to the company's securities, including the risk of being deemed a "resident enterprise" in China for tax purposes and the potential adverse U.S. federal income tax consequences for American holders if the company is classified as a "Passive Foreign Investment Company" (PFIC) Taxation While incorporated in the Cayman Islands with no local profit tax, the company faces the risk of being deemed a "resident enterprise" in China, which would subject its global income to a 25% corporate income tax and potential withholding tax on dividends for non-Chinese shareholders, alongside the risk of being classified as a PFIC for U.S. investors - As a Cayman Islands company, Momo is exempt from profit tax, income tax, or capital gains tax in the Cayman Islands[555] - There is a risk of being deemed a "resident enterprise" by Chinese tax authorities due to its "de facto management body" potentially being in China; if so, the company would be subject to a 25% Chinese enterprise income tax on its global income[556] - For U.S. investors, the company faces the risk of being classified as a "Passive Foreign Investment Company" (PFIC), determined by an income test (over 75% passive income) or an asset test (over 50% passive assets); while the company believes it was not a PFIC in 2018, future classification is not guaranteed[154][570][571] - If the company is classified as a PFIC, U.S. holders would face punitive tax rules upon disposition of ADS or receipt of "excess distributions," with gains potentially treated as ordinary income and subject to interest penalties[579] Quantitative and Qualitative Disclosures about Market Risk The company's primary market risks are interest rate risk, stemming from its substantial interest-bearing deposits, and foreign exchange risk, due to the majority of its revenues and costs being denominated in RMB while its ADS trade in USD, impacting reported financial performance and investment value - The company's primary market risks include interest rate risk and foreign exchange risk[591][592] - Interest Rate Risk: The company holds significant interest-bearing bank deposits, and a decrease in interest rates would negatively impact interest income; a hypothetical 1 percentage point decrease in interest rates would reduce annual interest income by approximately RMB 112.9 million[591] - Foreign Exchange Risk: The company's revenues and costs are primarily denominated in RMB, while its ADS trade in USD; fluctuations in the RMB to USD exchange rate affect the USD value of the company's financial performance; as of year-end 2018, the company held US$535.9 million in USD-denominated cash and time deposits, and a 10% depreciation of the USD against the RMB would reduce their RMB value by RMB 368.5 million[592][593][594] Part II Controls and Procedures Management assessed the company's disclosure controls and procedures and internal control over financial reporting as effective as of December 31, 2018, with the independent registered public accounting firm Deloitte concurring, though the assessment excluded the newly acquired Tantan Limited - Management assessed that the company's disclosure controls and procedures were effective as of December 31, 2018[603][604] - Management assessed that the company's internal control over financial reporting was effective as of December 31, 2018; however, this assessment did not include Tantan Limited, acquired in May 2018, whose assets and revenues constituted 31.1% and 3.1%, respectively, of the consolidated financial statements[605][611] - Deloitte, the company's independent registered public accounting firm, issued an unqualified audit report on the effectiveness of the company's internal control over financial reporting as of December 31, 2018[607][609] - No significant changes occurred in the company's internal control over financial reporting during 2018[618] Part III Financial Statements This chapter presents the company's consolidated financial statements for the three fiscal years ended December 31, 2018, prepared under U.S. GAAP and audited by Deloitte, including detailed notes on accounting policies such as revenue recognition, VIE consolidation, business combinations (Tantan acquisition), and the establishment of three operating segments in 2018 - The financial statements are prepared in accordance with U.S. Generally Accepted Accounting Principles (U.S. GAAP) and audited by Deloitte Touche Tohmatsu Certified Public Accountants LLP[638][671] - Effective January 1, 2018, the company adopted ASC 606, Revenue from Contracts with Customers, using the modified retrospective method, which had no material impact on financial position but increased disclosure requirements[381][701] - In 2018, the company identified three operating segments: Momo, Tantan, and QOOL, whereas prior fiscal years had only one operating segment[630][804] - The notes detail the acquisition of Tantan in May 2018 for a total consideration of RMB 4.714 billion, including cash and stock, which resulted in RMB 3.994 billion in goodwill[740][743]