Yalla Group Limited (YALA) Q2 2023 Earnings Call

Yalla Group Limited (NYSE:YALA) Q2 2023 Results Conference Call August 14, 2023 8:00 PM ET

Company Participants

Kerry Gao - Investor Relations

Tao Yang - Chairman and Chief Executive Officer

Saifi Ismail - President

Karen Hu - Chief Financial Officer

Conference Call Participants

Xueqing Zhang - CICC

Chenghao Li - CICC

Kaifang Jia - CITIC

Xiaoyue Hu - Haitong

Lincoln Kong - Goldman Sachs

Edward Wang - Credit Suisse

Rachel Guo - Nomura

Operator

Good morning and good evening, ladies and gentlemen. Thank you for standing by for Yalla Group Limited's Second Quarter 2023 Earnings Conference Call. [Operator Instructions] Today's conference call is being recorded.

Now I will turn the call over to your speaker host today, Kerry Gao, IR Director of the company. Please go ahead.

Kerry Gao

Hello, everyone, and welcome to Yalla's Second Quarter 2023 Earnings Conference Call. We released our earnings press release earlier today, and the release is now available on our IR website as well as on Newswire outlets. Before we continue, please note that the discussion today will contain forward-looking statements made under the safe harbor provision of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties.

As such, our future results may be materially different from the views expressed today. Further information regarding these and other risks and uncertainties is included in our earnings release and our annual report filed with the SEC. Yalla does not assume any obligation to update any forward-looking statements, except as required by law. Please also note that Yalla's earnings press release and this conference call include a discussion of unaudited GAAP financial information as well as unaudited non-GAAP financial measures. Yalla's press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited most directly comparable GAAP measures.

Today, we'll hear from Mr. Tao Yang, our Chairman and Chief Executive Officer, who will provide an overview of our latest achievements and growth strategies. He will be followed by Mr. Saifi Ismail, the company's President, who will briefly review our recent business developments. Mrs. Karen Hu, our Chief Financial Officer, will then provide additional details on the company's financial results and discuss our financial outlook. Following the management's prepared remarks, we will open up the call to questions.

With that said, I'd now like to turn the call over to our Chairman and Chief Executive Officer, Mr. Tao Yang. Please go ahead, sir.

Tao Yang

Thank you, everyone, for joining our second quarter 2020 earnings conference call. We delivered robust performance this quarter, growing both our top and bottom line. Despite the impact of the Ramadan holiday, our Q2 revenue reached $79.2 million, showing Q-on-Q growth of 7.8%. This exceeds the upper end of our guidance by 5.7%, manifesting the popularity of our products. Our continued efforts to drive quality growth and enhance our operating efficiency are also paying off.

In Q2, our non-GAAP net margin reached 42.6%. Our robust quarterly performance showcases our dedication and ability to successfully refine our operations. We have the unification of our flagship applications and optimize our user acquisition strategies. All of this holistically elevated the experience for our users, further boosting Yalla and Yalla Ludo's users' willingness to stay and pay on our app. As we discussed on our last call, 2023 has been a year of growth and development.

We are witnessing rapid digital transformation in the Middle East. The momentum we are seeing is arising from the recognition that the region's market opportunity may be strategically significant for global Internet games as well as robust support from local MENA governments, who are determined to build local industries. So they are dedicated to offering collaboration with various nations worldwide, actively participating in local ventures to drive global investment to domestic industries and increasing investments in disruptive products overseas to create future strategic opportunities. As the largest MENA-based online social networking and gaming company, Yalla is committed to facilitating this change in the MENA market, and we're be glad to see more conversations taking place. As we discussed last quarter, external collaborations are an important component of our go-forward growth strategy.

We are happy to share our experiences and localization competitive with more industry peers who are interested in exploring the MENA market. Our goal is to secure mutually beneficial collaborations that expand businesses in our dynamic markets where we see great potential in working together. Next, I'd like to share some important updates on Yalla Game's recent development. We're happy to report that Merge Kingdom has been officially launched across MENA and is now available on both the Apple Store and Google Play. Merge Kingdom is a strategy game that takes players on a foreign journey through the Arabian scene landscape.

It brings the world on Arabian folklore to life with stunning visuals, rich landscapes and beautiful Middle-Eastern music. The integration of Yalla's unique voice chat of games enhances the game's real time strategy element. Merge Kingdom is the first hard-core game to collaborate with Yalla Group on distribution. The game is being promoted on the homepages of both the App Store and Google Play for free, and was ranked as the number 2 downloaded game in Saudi Arabia on our app after it launched. We plan to gradually increase our investment in user acquisition in the next couple of months to increase the game's reach.

In terms of Yalla's first development -- developed hard-core game, Age of Legends, the team has been working on new game iterations. And the first step, Age of Legends was first launched in Turkey. And at the beginning of August, we successfully launched the Arabic version across the Gulf country. The game was the number 1 downloaded game in the low-tech game category on iOS in both UAE and Saudi Arabia. We will continue to monitor Age of Legends' operating and financial performance, and we look forward to sharing more details with you on our next earnings call.

The establishment of Yalla Game is an important strategic move for us. We will keep exploring opportunities in mid-core and hard-core games. For the 2 hard-core games we just launched, we will continue to work on future iterations to gain regional traction. We will also continue to expand our pipeline of games through both staff development and external distribution collaboration. We look forward to building our mid-core and hard-core game portfolios and expect this to serve as important growth drivers going forward.

Other vision is for Yalla to become the largest online social networking and gaming company in MENA. We have high aspirations in this region, and the whole team has been working tirelessly to achieve this goal. We are deploying many of possibilities and identifying how we can better serve MENA users' evolving needs for online services. Our strong cash flow and solid cash position are well suited to support this journey. Digital transformation in the Middle East is foreseeable, and the next 3 to 5 years will be a crucial period of development.

We are confident in our ability to capture growth opportunities in this promising and growing market. We will continue to enhance our investments in research and development and further explore new business opportunities while we work with potential partners from around the world to generate more global participation in MENA's exciting future of digital transformation.

Now I will turn this call over to our President, Mr. Saifi Ismail, for a closer look at our recent development.

Saifi Ismail

Hello, everyone. Thanks for joining us today. Let's take a closer look at our quarter 2 operations and the performance of our products. We are pleased to deliver robust quarter 2 results. Our monthly active users increased by 14.3% year-over-year, reaching 34.2 million.

In quarter 2, we rolled out an array of operation event on both Yalla and Yalla Ludo, defined our product features and systematically improved our customer service management. As a result, Yalla Group's paying user increased by 26.6% year-over-year to 13.4 million in quarter 2, demonstrating users' increasing willingness to pay on our platform. Our team will continue to refine our user acquisition and operational strategy to further improve operating efficiency. I'm pleased to share with you that during quarter 2, Yalla Group launched a new product developed to serve Arabic users' traditions in prayer, which played a significant role in Arabic users' daily lives. Our team launched this user friendly and ad-free app to provide users in the Arabic community with accurate praying time and a number of other customized functions related to prayer.

The introduction of this app aligned with Yalla Group's ESG program, demonstrating our dedication to honoring Arabic culture, which represents a significant portion of today's culturally diverse society. Next, it's my privilege to announce that, as a leading local gaming company, Yalla was invited by the Department of Economy and Tourism of Dubai to participate in the Dubai eSport and Game Festival 2023. Attending the festival in late June, we showcased our latest hard-core games and discussed the future of mobile games in MENA. Held under the government of the rural of Dubai, the Dubai eSport and Game Festival is the premier esport and gaming event in the MENA region. It introduces the latest development in the gaming industry through games, exports, esports, tournaments, influencer challenges and a game industry conference.

This event has also solidified Dubai as a global gaming destination and encourage a sense of community among gaming centers, offering an exceptional gaming experience teed in Arabic customs. Our 2 new games, Merge Kingdom and Age of Legends, gained great popularity among players at the festival. This reflects our strong local expertise, and the event also strengthened our brand awareness across the region. We are also pleased to report that in collaboration with Mohamed bin Zayed University of Artificial Intelligence, MBZUAI, we have launched a trailblazing program to cultivate new AI talents. As the first graduate-level research-based AI university in the world, MBZUAI works to enable the advancement of graduate students, businesses and government in artificial intelligence in the Arabic environment.

In addition to the internship program that's taking place at Yalla Group's headquarters in Dubai, the 2 parties will also focus on industrial development and explore the future application of cutting-edge technology to strengthen the alliance between industry and academia. As the largest online social networking and gaming company in MENA, over the past 7 years, Yalla Group has amassed a great deal of practical experience in natural language processing, computer vision and recommendation system that's set with Arabic sentiment and Arabic users custom. We believe our cooperation with MBZUAI will provide both parties with the new ideas, enhance the application of AI innovation in the Arabic environment and support the acceleration of digital transformation in the region at large. Last but not least, we are very proud to announce that for 3 years in a row, Yalla Group was selected by Data.ai as 1 of the top 30 publishers headquartered in Europe, the Middle East and Africa, EMEA, in the 2023 publisher awards. In the Middle East region, we were also recognized as being the number 1 publisher based on consumer spending.

Data.ai is a well-known global unified data analysis platform for the mobile application market. Our number 1 rating validates our deep local know-how in this increasingly competitive market and the strength of our monetization capabilities. We are honored to receive the Data.ai prestigious award and look forward to continuously providing MENA users with high-quality customized digital products to meet the fast growing demand of online users. In conclusion, I would like to echo the sentiment that Yalla's vision is to become the number 1 online social networking and entertainment platform in MENA region. As MENA's digital transformation gathers pivotal momentum over the next 3 to 5 years, we will leverage our extensive operating experience in this region, continue to invest in R&D and roll out new products tailored to local user habits and references.

We will also work to expand our partnership with local channels and look forward for collaboration opportunities with industry peers around the globe who are eager to explore the MENA market. Keeping our group vision in mind, we will remain faithful to our core values of prioritizing our users, embracing diversity and operating within a simple, pragmatic, pioneering and enterprising approach as we work to achieve our goals.

With that, I will now turn the call over to our CFO, Karen, who will discuss our key financial and operating results.

Karen Hu

Thank you, Saifi. Hello, everyone. Thank you for joining us today. In the second quarter, we achieved solid top and bottom line growth as we continue to pursue the high-quality development of our business. We remain committed to executing our disciplined cost management and ROI-based marketing strategy, further elevating our overall operational efficiency.

We have also strategically leveraged the high interest rates to achieve higher return to support our strong cash position. As a result, we maintained a healthy level of profitability with a net margin of 35.7% and a non-GAAP net margin of 42.6%. As we move into the second half year 2023, we will continue to leverage our high-quality growth strategy and further enhance our efficiency. We believe our ample cash position and strong execution capabilities will equip us to see future opportunities that foster sustainable growth and generate value for all of our stakeholders. Now I would like to walk you through our detailed financials for the second quarter of 2023.

Our revenues were $79.2 million in the second quarter of 2023, a 4.1% increase from $76.1 million in the second quarter of last year. The increase was primarily driven by the broadening of our user base and our enhanced monetization capabilities. Now let's take a look at our costs and expenses. Our total costs and expenses remained relatively stable at $55.3 million in the second quarter of 2023 compared with $55.2 million in the same period last year. Our cost of revenues decreased by 3.2% to $28.3 million in the second quarter of 2023, down from $29.3 million in the same period last year.

The decrease was primarily due to a lower commission fees paid to third-party payment platforms as we diversified our payment channels as well as lower technical service fees as a result of our more disciplined cost management. Cost of revenues as a percentage of total revenues decreased from 35.8% in the second quarter of 2023 compared with 38.5% in the same period last year. Our selling and marketing expenses were $12.4 million in the second quarter of 2023, a 10.4% increase from $11.2 million in the same period last year. The increase was primarily due to higher advertising and marketing promotion expenses related to increased user acquisition efforts and the promotions associated with our expanding product portfolio. Selling and marketing expenses as a percentage of total revenues remained relatively stable at 15.6% compared with 14.7% in the same period last year.

Our general and administrative expenses were $8 million in the second quarter of 2023, a 15.4% increase from $6.9 million in the same period last year, primarily due to an increase in incentive compensation and an increase in professional service fees. General and administrative expenses as a percentage of total revenues remained relatively stable at 10.1% compared with 9.1% in the same period last year. Our technology and product development expenses were $6.6 million in the second quarter of 2023, a 14.8% decrease from $7.7 million in the same period last year, primarily due to the appreciation of U.S. dollar, which resulted in a decrease in the reporting currency amount of salaries and benefits for our technology and product development team, showing one of the benefits of our globalized talent acquisition strategy. Technology and product development expenses as a percentage of total revenues decreased from 10.2% in the second quarter of 2022 to 8.3% in the second quarter of 2023.

As such, our operating income increased to $23.9 million in the second quarter of 2023 compared with $20.9 million in the same period last year. Excluding share-based compensation, our non-GAAP operating income in the second quarter of 2023 was $29.4 million. Our interest income was $4.6 million in the second quarter of 2023 compared with $176,000 in the same period of 2022, primarily due to a significant increase in interest rates applicable to our bank deposits and the continued increase in the company's cash position. Our income tax was $821,000 in the second quarter of 2023 compared with $780,000 in the same period last year. Moving to our bottom line.

Our net income increased by 39% to $28.3 million in the second quarter of 2023 compared with $20.4 million in the same period last year. Excluding share-based compensation expenses, non-GAAP net income for the second quarter of 2023 increased by 18% year-over-year to $33.8 million. Next, I would like to briefly go through our liquidity and cash capital resources. Our cash position remains solid. As of June 30, 2023, we had cash and cash equivalents, term deposits and short-term investments of $510.5 million compared with $453 million as of December 31, 2022.

Under our share repurchase program that began May 21, 2021, and has since extended by our Board through May 21, 2024, we have repurchased 2,302,141 ADS or Class A ordinary shares in the open market cash repurchases, totaling approximately $27 million as of June 30, 2023. Moving to our outlook. For the third quarter of 2023, we expect our revenues to be between $73 million and $80 million. The above outlook is based on the current market conditions and reflects the company's management's current and preliminary estimates of the market and operating conditions and the customer demand, which are all subject to change.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today comes from Xueqing Zhang with CICC.

Xueqing Zhang

Congrats on the strong quarter. I have three. First, with regard to Yalla Ludo, based on stable growth yield quarter-on-quarter, which indicated that the company, I believe, has more growth potential as the paying ratio or ARPU. And to regard to your hard-core games, can management share what you see as the advantage of getting more involved with the hard-core games? And what are the expected marketing expenses for the 2 games in the third quarter and first quarter? And how will they impact with our community?

Tao Yang

Thank you very much for the questions. I will take the first two, and I think our CFO, Karen Hu, will take third one. For the first question for the paying ratio, or ARPU, we started our Yalla and Yalla Ludo early in the MENA market and we're able to obtain a group of users who are highly loyal and have high needs for online social networking and gaming services. Our users have shown a strong willingness to engage and pay on our platform over the past 7 years. Our paying ratio in Q1 reached 41%.

This quarter, it came down slightly to approximately 39%. So for the first half of the year, our paying ratio has remained strong, which is higher than we see from many tier products in the industry. We have hosted the area for our operating events in the past few quarters, which are designed to convert more users into paying users. I don't want to guide you to a higher paying ratio at this stage. I think it's already robust.

In terms of ARPU, I think, yes, they are more tactics we can try to improve its performance. And for the hard-core games question, we are dedicated to serving the MENA market. And we are also the largest local online social networking and gaming company. With this reach and our expansion goals, exploring the mid-core and hard-core game business is a necessary move for the company. It's also an important step towards achieving our vision in terms of advantages.

I think there are two important parts. First of all, gaming is the fast-growing market in MENA. And it's also the industry that many MENA countries are focusing on developing. We identified mid-core and hard-core games to be one of the important business drivers for our company in the future. And we also have a highly engaged user community that we can leverage on.

Secondly, gaming business is the cash driving, and with support from the strong cash position, we may be able to explore more Internet-related business in the region. As you may already know, money workers now don't have a dominant player in MENA working yet. Hope this answers your question, Xueqing. And our CFO will be taking the last question. Thank you.

Karen Hu

Thank you, Tao. Thank you for your question, Xueqing. For the second half of this year, we budgeted at least more than $1 million to invest in promoting these two, mid-core and hard-core games. Our budget is dynamic, and we will adjust it according to our users' feedback, and it's possible for us to invest more if we see it's needed.

We have just started to promote Merged Kingdom in our Yalla community, and we were already seeing better retention and willingness to pay. Early feedback has been positive, and we will continue to monitor user trends. Hope I answered your question. Thank you.

Operator

And our next question today comes from Chenghao Li with CICC.

Chenghao Li

Congratulations on management's solid quarter. I have 2 questions. First, which is a follow-up question. Can management share more detail about what will the financial impact be of launching the mid and hard-core games. And secondly, we can see that Yalla Group often achieves quite a high performance in the second quarter during the off-season of Ramadan.

So what are the main driving forces behind this? And how should we think about this in terms of the signal changes in the third and fourth quarter?

Karen Hu

Thank you, Chenghao. I'll take the first question and leave the second one to our CEO. If you are referring to the impact of the potential investments in these 2 hard-core games' promotion to our group margin, I would like to emphasize that our annual margin guidance, which is over 30%, we provided at the beginning of the year already includes this anticipated expenses. So far, our margin trend is consistent with our expectations. And because of our quality growth strategy at the group level, our group margin is actually doing a little better than we promised at the beginning of this year.

In terms of potential revenue contribution, we started the official promotion of both products in Q3, and we are gradually increasing the investments in sales and marketing. Looking at the ranking on some third-party data platforms, we see that Merge Kingdom's growth in ranking under the same category in MENA is already about the same level as some successful SLG games. The whole team is working on that, and our goal is to improve the game's performance further. I hope I answered your question.

Tao Yang

Chenghao, thank you very much for your question. The second one for the like Ramadan or the main driving forces, I think the most influential seasonality impact we see is still Ramadan, which really falls in Q2. For the other quarters, I don't see seasonality as a very strong factor. Yes. We delivered a very good performance in Q2 this year.

But if we look into our revenue turns on a daily or weekly basis in Q2 users, this show less willingness to pay during Ramadan. However, our product and operational teams were able to roll out popular events and new features on our platform after Ramadan ended, and in the later part of Q2 our revenue growth showed solid recovery. I think the key driver of this quarter's strong performance is still closely tied to our ability to roll out the event at our customers for local user preference as well as our ability to provide users with better experience on the platform. Thank you.

Operator

And our next question today comes from Kaifang Jia with CITIC.

Kaifang Jia

I have a question about your gaming business. So what's the specific launch strategy and monetization plan for the mid- and hard-core gaming businesses?

Jianfeng Xu

Kaifang, thank you for your question. Regarding the sales and marketing strategy for our hard-core games, there are 2 important points we care about. First of all, for any new mid and hard-core games promotions, building user communities with good dynamics is very significant. And that's highly related to the pace and tactics we use in marketing. Additionally, the pace is quite different for SLG games and RPG games. A lot of know-how is involved, and we need to be pretty accurate in controlling the pace. Secondly, we really care about the ROI. We're monitor ROI on a daily basis as one of the key metrics we refer to. And in terms of the monetization of the hard-core games, I will say in-app purchase are the main parts.

Operator

And our next question comes from Xiaoyue Hu with Haitong.

Xiaoyue Hu

Congratulations on a very strong quarter. So I have two questions today. Firstly, could you please provide updates on YallaChat and other new products? And my second question is what are the future growth drivers for the Yalla and Yalla Ludo legacy products?

Tao Yang

I'll take the two questions. As we shared earlier, our YallaChat is the instant message product customized for Arabic users and with that, our conservations with respect to local communities' social habits and preferences. The product has met the goal with that for its first stage of promotion soon after its launch and has shown strong retention since then. Recently, we have focused more on designing the product features and rolling out new functions. For example, YallaChat now supports 32 users joining the same group video chat and we also launched the in-app emoji shop.

We will invest more resources in refining the product before we begin the second round of promotion. Another update I would love to share with you is about what's building on the animation social world and about how we build it. We plan to fill it in combination with mid-core and hard-core games to boost the gamification of the product. We will keep you posted on our progress on our new product. And for the second question about the future growth drivers for Yalla and Ludo.

Our 2 flagship apps, Yalla and Yalla Ludo, have shown strong popularity in the MENA market, and we are very confident this trend will continue. In terms of user growth, we'll stick with our current strategy to obtain quality growth and focus more on the ROI instead of only the community side. We will also continue to strategically refine our operations and keep rolling out new features and breaking events tailored to local users' preferences to boost user engagement and ARPU. We expect our flagship applications to keep their current steady pace of growth.

Operator

And our next question comes from Lincoln Kong with Goldman Sachs.

Lincoln Kong

So the management team discussed this trend after increasing interest from global Internet companies to the Middle East market during this prepared remarks session. How is this going to affect Yalla's stability in the region? How do you see the competitive landscape changing under this context?

Tao Yang

Thank you very much, Lincoln. As we discussed in our remarks session, MENA's macro environment is very good, and the local government's vocation to development is strong. More and more resources, including talent and investments are being directed to this market. I think one important thing we have noted is that since the second half of last year, we have been more frequently invited to discuss opportunities in the new end market with industry peers. More conversations are happening.

And in this process, we are able to learn from each party's insights and intentions in what they have and what they need at this point and discuss ways to collaborate that are mutually beneficial. With all these creative minds and resources, it's not hard to see that the market is going to grow in the next 3 to 5 years. In terms of the competitive landscape, in recent years from strong Internet companies gradually entered the market, such as Bytedance. Some mobile gaming apps are also performing very well in this market. This is very exciting.

It's a testament to the region's market potential as well as it's also a sign of its vibrant development. I want to reiterate that competition is never bad. It inspires us to better serve our users, research new technologies and industry trends and drive collaboration and innovation. As a leading player in this region, we see the unfolding of this event as an opportunity. We are taking proactive steps to cement our leadership position and remain confident in our capabilities after all this year.

Operator

And our next question comes from Edward Wang with Credit Suisse.

Edward Wang

Congratulations on the robust results. So my question is that can management share more color about revenue growth target in the second half of the year?

Karen Hu

Edward, thank you. Thank you for your question. For our flagship applications, we expect their current steady pace of growth to continue, in line with the annual revenue guidance we provided at the beginning of the year. As a reminder, this guidance excludes the potential contribution from our mid-core and hard-core games business. We recently started the official promotion of our two games, and there are still 4 more months from now on to the end of this year.

So we will keep you posted on our progress once we have a more accurate prediction.

Operator

And our next question comes from Rachel Guo with Nomura.

Rachel Guo

Congratulations on the very good outlook. I have a question about the net profit margin. Could management share more color on net profit margin trend in the second half of this year?

Karen Hu

Thank you. Thank you for your question. Since we have promotions for our mid-core to hard-core games in quarter 3 and quarter 4, there may be some fluctuations in our quarterly net margin. It depends on our users' feedback and how much we will end up investing. Taking the potential expenses of mid-core to hard-core games' sales and marketing into account plus the benefits of our operating refinements and the higher interest rates that -- which we are driving better returns on our cash position, we expect Yalla's 2023 annual non-GAAP net margin to increase to about 35%. Hope I answered your question.

Operator

As there are no further questions now, I'd like to turn the call back to the management for closing remarks.

Kerry Gao

Thank you once again for joining us today. We look forward to speaking with you in the next quarter. If you have further questions, please feel free to contact Yalla's Investor Relations or Piacente Financial Communications. Both parties' contact information is available on today's press release as well as on our company website. Thank you.

Operator

Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You can now disconnect your lines, and have a wonderful day.