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Edited Transcript of 3690.HK earnings conference call or presentation 23-Aug-19 11:00am GMT

Q2 2019 Meituan Dianping Earnings Call

Aug 27, 2019 (Thomson StreetEvents) -- Edited Transcript of Meituan Dianping earnings conference call or presentation Friday, August 23, 2019 at 11:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Shaohui Chen

Meituan Dianping - CFO & Senior VP

* Xing Wang

Meituan Dianping - Co-Founder, Chairman & CEO

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Conference Call Participants

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* Alex C. Yao

JP Morgan Chase & Co, Research Division - Head of Asia Internet and New Media Research

* Alicia Yap

Citigroup Inc, Research Division - MD and Head of Pan-Asia Internet Research

* Chun Man Poon

Morgan Stanley, Research Division - Equity Analyst

* Eddie Leung

BofA Merrill Lynch, Research Division - MD in Equity Research and Analyst

* Hao Dai

Sanford C. Bernstein & Co., LLC., Research Division - Research Analyst

* K.C. Fong

Crédit Suisse AG, Research Division - Regional Head of Gaming & Lodging Research and Director

* Ronald Keung

Goldman Sachs Group Inc., Research Division - Executive Director

* Yuan Liu

UBS Investment Bank, Research Division - Co Head of HK and China Internet Research

* Yue Wu

China International Capital Corporation Limited, Research Division - Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the Meituan Dianping Second Quarter 2019 Earnings Conference Call. (Operator Instructions) Please note today's event is being recorded.

I'd now like to turn the conference over to [Scarlett Yu], Vice President and Head of Capital Markets. Please go ahead.

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Unidentified Company Representative, [2]

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Thank you, operator. Good evening and good morning, everyone. Welcome to our second quarter 2019 earnings conference call. Joining us today are Mr. Xing Wang, Chairman and CEO; and Mr. Shaohui Chen, Senior Vice President and CFO of Meituan Dianping. For today's call, management will first provide a review of the second quarter 2019 results and then conduct a Q&A session.

Before we start, we would like to remind you that our presentation contains forward-looking statements, which include a number of risks and uncertainties, and may differ from actual results in the future. This presentation is based on our management accounts, which have not been audited or reviewed by our auditor. This presentation also contains unaudited non-IFRS financial measures that should be considered in addition to and 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-IFRS measures, please refer to the disclosure documents in the IR section of our website.

Now I will turn the call over to Mr. Xing Wang. Please go ahead, Xing.

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Xing Wang, Meituan Dianping - Co-Founder, Chairman & CEO [3]

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Thank you, [Scarlett]. Hello, everyone, and welcome to Meituan Dianping's Second Quarter 2019 Earnings Call. In this quarter, we continued to deliver strong business performance. Our GTV increased by 28.7% year-over-year to RMB 159.2 billion. Total revenue increased by 50.6% year-over-year to RMB 32.7 billion. For the 12 months ended June 30, 2019, annual transacting users on our platform grew by 18.4% year-over-year to 422.6 million. And annual active merchants on our platform grew by 16.2% year-over-year to 5.9 million. In addition, the annual number of transactions each transacting user made on our platform increased to 25.5 in the 12 months ended June 30, 2019 from 21.4 in the prior year period.

During this quarter, our company recorded positive adjusted net profit for the first time, and our positive adjusted operating profit in the food delivery segment turned positive for the first time as well. While we continue to solidify our market-leading position, we have further improved the unit economics of our food delivery business and are conducting new initiatives with more discipline. We believe that our company is on the right track to achieve healthy and sustainable long-term growth. As an integrated e-commerce platform for local services in China, we have further enhanced our thriving and self-reinforcing ecosystem, increasing penetration through strong brand recognition on both the demand side and the supply side. Going forward, we will stay committed to creating value for consumers and merchants while sharing in the growth and success of our merchants in return.

Now I would like to highlight the performance of each segment in the second quarter of 2019. I will start with our food delivery segment. In the second quarter, the number of food delivery transactions increased by 34.6% year-over-year to 2.1 billion, while GTV increased by 36.5% year-over-year to RMB 93.1 billion. This quarter, we further demonstrated that we have the capability and flexibility to strengthen our market-leading position while improving the financial performance of our food delivery business at the same time. Thanks to our clear advantage in user base, merchant base, delivery networks and nationwide network effects, our market share continued to increase. Also, due to our enhanced operational efficiency and improved economies of scale, the unit economics of our food delivery business continued to improve on both a year-over-year and a quarter-over-quarter basis.

On the user side, we further enhanced the user engagement through our Food Delivery Membership Program this quarter. We launched our Food Delivery Membership Pilot Program in the second half of 2018. And we are pleased to see that it continues to yield encouraging results. As a part of the membership program, we offer exclusive benefits to monthly membership subscribers such as sizable discount coupons that are valid for 1 month. This program has helped to further enhance our platform's user stickiness. Notably, the average purchase frequency of our monthly membership subscriber has more than tripled the average purchase frequency of our non-membership subscribers. Moreover, the average purchase frequency of our membership subscribers increased meaningfully during the second quarter.

In June, we also launched a joint membership program with Tencent Video and sold 400,000 joint memberships in total through this partnership throughout the month. This is just the beginning of our membership program trials. In the future, we will continue to explore cooperative opportunities and collaborations with the partners in our ecosystem to further enrich membership benefits. On the merchant side, we continue to leverage our in-depth understanding of the food delivery business to develop innovative online marketing products, enhance food delivery merchants' exposure to potential consumers and boost food delivery merchants' marketing efficiency.

For example, we offer merchants: display ads that help them promote their brand awareness; performance-based ads that help them enhance their exposure to consumers' search results; and marketing tools that enable them to dispense coupons customized to targeted consumers; and subscription-based services that offer them value-added services such as user review management, peer comparison and online storefront decoration. Our continuous innovation in product and services not only help merchants to improve their marketing efficiency, but also deepen the cooperative relationship between merchants and our platform. We will continue to expand our product offerings, creating more value and targeting a win-win ecosystem for food delivery merchants going forward.

On the delivery side, thanks to favorable weather conditions, the robust increase to order volume and the improved management of our delivery network, we kept our delivery costs per order well under control, which have led to a significant improvement in the segment's gross margin. Although the delivery cost per order is strongly influenced by seasonality, our impressive year-over-year improvement in the quarter further highlighted that our infrastructure-enabled food delivery business model has a clear path to profitability. Thanks to our continuous investment in our food delivery network and order dispatching system over the past few years, we have not only strengthened our leading position and established competitive advantages on both the user side and the merchant side, but also achieved greater economies of scale and enhanced network effect through improvements to our delivery capability.

We believe our last-mile delivery network is extremely valuable as it will enable us to continue growing our food delivery business, expanding our business scope. In the future, we will continue to invest in our delivery network and order dispatching system while developing other strategic initiatives to drive the long-term growth across the industry and our ecosystem.

During the quarter, the number of orders in our food delivery business surpassed 22.9 million. However, as we mentioned in the previous earnings call, the industry had transitioned into a stage of moderating volume growth that will be more driven by increased purchase frequency instead of the addition of new users. We believe that the supply side is currently the main bottleneck to increase the purchase frequency of our mature user cohorts.

In order to address this problem, we started to work with the restaurants to help them further diversify their offerings on their menus while exploring new delivery models to adapt to their new offerings. We firmly believe that these efforts help to make food delivery affordable to consumers from all walks of life. It enables us to further penetrate the day-to-day food consumption habits of urban Chinese consumers. It will take time for this effort to pay off but they are worthwhile and will ultimately help us to build the runway for the sustainable long-term growth of our food delivery business. We will continue to make investment in the food delivery sector.

Now let's turn to our in-store, hotel & travel segment, which revenue again grew rapidly during the quarter. Our platform has become the preferred location for consumers to search for local services as well as for merchants to make services offerings and attract new users. Notably, our increasingly diversified product offerings and promotional campaign enable merchants to reach consumers with greater marketing efficiency.

As a result, we have further improved our presence and influence among merchants. Our Must Lists series is a good example of this. Our launch of the Must-Eat List for top restaurants in 2017 was well received by both merchants and consumers. In the second quarter of 2019, we expanded the Must List series to include the Must-Shop List for top shopping malls, the Must-Visit List for top tourist destinations, the Must-Stay List for top hotels and resorts.

Notarized by a credible third party, our Must List was built using authentic consumer feedback and aim to provide the consumers with reliable travel and purchase guides. 171 shopping malls were selected for our Must-Shop List; 578 tourist attractions were selected for our Must-Visit List; and 876 hotels were selected for our Must-Stay List. All of our featured selections enjoyed substantial improvements in both consumer traffic and engagement.

For example, in June, a shopping mall on our Must-Shop List reported a year-over-year increase of around 60% in shopping traffic and 430% in shopper reviews. For recommended tourist attractions on our Must-Tour List, consumer reviews more than doubled year-over-year. For recommended hotels, domestic room nights consumed more than doubled while consumer reviews increased by around 75% year-over-year.

Our Must Lists further enhanced our brand awareness and influence for both consumers and merchants across different service categories. Must Lists, which are based on authentic and dynamic consumer reviews, help recommended merchants generate higher sales and volumes and acquire greater brand influence as well as guide them to improve their operation and product offering.

The success of our Must List further demonstrate our leadership as a comprehensive local search platform helping consumers to discover and explore local life in a wider range of categories, including food, living, travel, shopping and entertainment. It should be noted that the Must List is just one example of our many successes in product developments and business operations.

Going forward, we will continue to innovate to better serve merchants and consumers through a broader range of creative product offerings. I will now turn to our third segment, new initiatives and others.

During this quarter, we further narrowed our operating losses with new initiatives on both quarter-over-quarter and year-over-year basis.

Specifically, we continue to narrow the operating loss of our bike-sharing business and integrate our car-hailing business model. In fact, at June 30, we have expanded our car-hailing business to 42 cities through the new aggregated model. While we further narrow the operating losses of our new initiatives, we will continue to remain highly alert to opportunities which correspond to our food-plus platform strategy, explore new areas with this discipline and make investment based on our ROI assessment.

For instance, in grocery retail, especially fresh food retail, there is a large total addressable market with relatively low on-air penetration. We see this as a great opportunity to expand into and are exploring opportunities in the grocery retail business, through both our self-operated marketplace model. Our marketplace model, Meituan Instashopping or (foreign language) in Chinese, experienced strong growth from high ticket size category, such as flowers and medicines.

During the quarter, for example, the GTV of both flower and medicine categories increased by more than 100% year-over-year.

In addition, we started to bring traditional flower markets onto our platform in certain cities by helping them to digitize their products and inventories as well as providing them with on-demand delivery services to better serve consumers. We launched our self-operated model, known as Meituan Grocery or (foreign language) in Chinese in January 2019. After making progress with this model in Beijing and Shanghai, we are also currently exploring further opportunities in Wuhan.

Through our self-operated model, we still have small grocery stores in population-dense community areas and focus on providing a convenient grocery shopping experience to consumers nearby as well as a high-frequency core SKUs for home cooking ingredients and fruits. More grocery stores not only shorten the physical distance between consumers and products, but also effectively satisfy consumers' demand for convenience and reasonably priced high-quality grocery products.

In this quarter, we further solidified our leading position as a one-stop e-commerce platform for local services in China. We are pleased with our results so far and we are far from satisfied. We will continue to execute our food-plus platform strategy and explore new initiatives to drive long-term growth and enhance our ecosystem.

Moreover, as an enterprise that supports social responsibility, we not only strive to offer high-quality services to merchants and consumers, but also creating million of new jobs. We are very proud of the fact that we have provided employment opportunities to around 2.7 million delivery riders and various career development programs for the new urban youth. We are only at the beginning of the journey, and we'll remain committed to helping people eat better and live better through technology innovations.

With that, let me turn the call over to the Shaohui for financial update. Shaohui?

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Operator [4]

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Apologies. This is the operator. It looks like their line has dropped. We're standing by for them to dial back in. Apologies.

(technical difficulty)

And we have reconnected them. Let me join them in. Pardon me, you're now live.

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Unidentified Company Representative, [5]

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Shaohui, please go ahead. Thank you.

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Shaohui Chen, Meituan Dianping - CFO & Senior VP [6]

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Okay, thank you. Hello, everyone. I will now go through our second quarter financial results. In the second quarter, our total revenue reached RMB 22.7 billion, up by 50.6% year-over-year. This growth was mainly driven by the increase in GTV and overall monetization rate.

Our GTV in the second quarter increased to RMB 159.2 billion, up by 28.7% year-over-year as a result of our growing transacting user base and the increasing purchase frequency of our users.

Our monetization rate for the second quarter reached 14.3%, up from 12.2% in the same period of 2018 and driven by the increase in the monetization rate across all of our major business segments.

Our total gross profit for the second quarter increased to RMB 7.9 billion, up by 179.5% year-over-year. Gross profit margin was 35% compared to 26.4% in the previous quarter and 18.8% in the second quarter of 2018. This year-over-year increase was mainly due to this robust growth of our business scale, constant improvement to the gross margin of our food delivery business and the consistent narrowing of losses of our new businesses.

Selling and marketing expenses as a percentage of revenue further decreased to 18.3% in the second quarter of 2019 from 25.7% in the second quarter of 2018, attributable to both our healthy operating leverage as well as optimization of our spending on branding and marketing. R&D expenses as a percentage of revenue decreased to 9% from 11% in the prior year period. G&A expenses as a percentage of revenue decreased to 4.6% from 6.5% in the prior year period as well. Our adjusted EBITDA continued to improve, reaching RMB 2.3 billion in the second quarter of 2019.

More specifically, we achieved a positive adjusted net profit on a consolidated basis of RMB 1.5 billion for the quarter. Adjusted net profit as a percentage of revenue was positive 6.6% compared to negative 21.3% in the second quarter of 2018 and negative 5.4% in the first quarter of 2019.

The improvement of adjusted net profit and adjusted EBITDA on a year-over-year basis are attributable to both our ongoing efforts in improving our core businesses' operating margin and streamlining the operation losses of our new initiatives. Furthermore, favorable seasonality also contributed to the quarter-over-quarter improvement in our overall profitability.

Let's now take a look at our segment reporting. For food delivery, despite the industry transition into a more moderate growth stage, we continued to grow our food delivery transacting user base and increased user purchase frequency year-over-year in the second quarter. We also continued to increase our market share amidst intense industry competition during the quarter.

As a result, the number of food delivery transactions increased by 34.6% year-over-year to 2.1 billion transactions in total. Furthermore, food delivery GTV increased by 36.5% year-over-year to RMB 93.1 billion while food delivery revenue increased by 44.2% year-over-year to RMB 12.8 billion. The profitability of our food delivery segment continued to improve during the second quarter on both a quarter-over-quarter and a year-over-year basis.

More importantly, we were pleased to see that the adjusted operating profit for the food delivery segment became positive during this quarter for the first time, demonstrating our capability and flexibility to both strengthen our market position and improve our financial performance.

Monetization rates for food delivery increased from 13.1% to 13.8% year-over-year. Gross profit of our Food Delivery business increased to RMB 2.9 billion in the second quarter, up by 102.8% year-over-year while our gross margin expanded significantly to 22.3% from 15.8% in the prior year period and from 14.4% in the previous quarter.

As a result of our continued efforts in product innovation, we further expanded our online marketing product to help food delivery merchants enhance their exposure to potential consumers and improve marketing efficiency. This product diversification has further accelerated the adoption of our online marketing services by food delivery merchants and gradually improved our monetization rates for food delivery on a year-over-year basis.

Gross margin and operating results for the segment are usually the highest during the second quarter of the year, attributable to the sufficient delivery capacity and the favorable weather conditions across the country that helped to minimize the seasonal incentives paid to delivery riders. In addition, our business scale continued to grow and the daily average order volume surpassed 22.9 million in the quarter, further improving the order density.

Favorable weather conditions and economies of scale have allowed us to continue improving this delivery efficiency and minimizing the delivery cost per order, thereby improving the gross margin of our food delivery segment meaningfully on both a quarter-over-quarter and a year-over-year basis. However, we are still prioritizing growth rather than profitability for our food delivery business. We may increase our investment during the rest of the year to drive the growth of food delivery business when we see the ROI and hit our target.

Now turning to our second segment, in-store, hotel & travel. Revenues in the segment increased to RMB 5.2 billion, up by 42.8% year-over-year, which was mainly due to the increases in the number of active merchants, increases in the average revenue per active merchants for our in-store dining and other local services as well as increases in both the number and average daily rates of domestic room nights consumed on our platform.

Gross profit increased by 39.7% year-over-year to RMB 4.7 billion. Gross margin slightly decreased from 90.8% to 88.8% on a year-over-year basis mainly due to the increases in depreciation of our property, plant and equipment, bandwidth and server fees as well as increases in online traffic costs to support the growth of our online marketing revenue.

For in-store dining services, the accelerated adoption of online marketing services by in-store dining merchants led to rapid growth in online marketing revenue. Online marketing restaurant accounts and continued diversification of quality selection on our platform continued to drive the steady growth of transaction-based commissions for our in-store dining services year-over-year.

For other local services. Online marketing continue to drive our robust revenue growth. In this quarter, the number of active marketing merchants in other local services grew by more than 50% year-over-year.

In addition, we continue to carry out product innovations and promotional campaigns. In this quarter, we launched the June 18 Marketing Festival to enable other local service merchants to enhance their brand exposure and acquire more online traffic. This promotional campaign has generated impressive results and helped to drive the growth of our transaction-based commissions on a year-over-year basis.

For example, during the 6-day promotion around June 18, our transaction users within the medical aesthetic category contributed around RMB 670 million in GTV on the platform, increasing transaction-based commissions in this category by more than 230% year-over-year during this quarter. For our hotel booking services, domestic room rights maintained a healthy growth rate of 28.9% year-over-year.

In April, we launched our hotel plant ad campaign to grow our high-class hotel booking business and help high-class hotels to promote their non-lodging services such as restaurant and bar, wedding and events, spa incentives as well as leisure and entertainment. As part of this campaign, we help hotels to move their non-lodging services from offline to online by digitizing their product display, bookings, transactions and customer review. These efforts help to enhance the exposure of their high-quality services to potential customers, generate a higher transaction volume from non-lodging services and continuously improve their service quality based on customer reviews. The result of this campaign were encouraging and more than 20 high-end hotel chains participated.

Let's now turn to our third segment, new initiatives and others. In the second quarter, revenues in the segment increased to RMB 4.6 billion, up by 85.1% year-over-year. The segment recorded a gross profit of RMB 421.1 million and gross margin turned positive in the quarter at 9.1%. The 85.8 percentage point improvement on a year-over-year basis was mainly due to both the improved gross margin of our car-hailing services as we roll out our aggregated car-hailing model as well as last segment and the margin improvement to our bike-sharing business. For bike-sharing, the operating losses narrowed significantly from last quarter, which was mainly attributable to the significant reduction in depreciation expenses as some bikes reached the end of their useful life and will no longer result in integration expenses while new bikes have not all been put in place to replace that.

We also continue to improve our pricing metrics and started to reasonably increase both the charge per ride and monthly subscription fee throughout several cities. For our Restaurant Management System business, our focus remains on optimizing product and increasing the coverage of high-quality merchants in order to lay a better foundation for future monetization. In this quarter, the number of high-quality merchants continued to grow from last quarter.

Now moving on to our cash position. As of June 30, 2019, our cash, cash equivalents and short-term investments totaled RMB 58.6 billion.

Overall, we further improved operational results and cash generating capabilities of our core businesses and have been more prudent when carrying out our new initiatives. However, I would like to remind our audience that our corporate philosophy prioritizes long-term growth over short-term profitability and that we will continue to make investments to drive the sustainable growth of our company. For example, we will may selectively increase spending on effective marketing channel to drive the growth of our mobile app's DAU and MAU. We may allocate more resources to expand our membership program by offering more exclusive benefits to our membership subscribers.

We may also recruit more talent for new cutting edge R&D projects. In addition, we will continue our discipline and experiment in new initiatives. Going forward, as we invest, we will continue to accelerate our investment strategy and adjust our capital allocation based on our latest filings and [in-depth strength] as necessary to achieve a better ROI. We believe these long term investments will eventually bring investors optimal returns. This concludes our prepared remarks.

Operator, please open up the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Today's first question comes from Ronald Keung of Goldman Sachs.

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Ronald Keung, Goldman Sachs Group Inc., Research Division - Executive Director [2]

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Congratulations on the strong results. My question will be on food delivery this time again. So with unit economics now turned comfortably profitable as mentioned on the call and competition seemingly stabilizing. Just want to hear are we happy with the market share level roughly at this point? And in terms of priority, will we focus more on improving, let's say, unit profit further, understanding the seasonality as well, but -- or to expand our market share further? So I would like to hear your thoughts.

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Xing Wang, Meituan Dianping - Co-Founder, Chairman & CEO [3]

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Thank you. As we have mentioned in many occasions, we have clear advantages in consumer base, merchant base and delivery network in terms of both scale and quality. And we also have unparalleled nationwide offline operation capability and deeper insights in the industry.

So as a result, we were able to gain market share and improve the unit economics at the same time in the past quarter. Positive adjusted operating profit for food delivery is the result of our competitive advantage and economies of scale. However, it should be noted that the lower delivery cost per order from seasonality also contributes significantly to these results. And we believe that this market is large enough to have multiple players. This is still a new industry at its very early growth stage and capable players will benefit from this high-potential market. We will continue to focus on improving our service quality, operating efficiency and making investment for growth where we see healthy ROI. Market share gain will be a natural result. We will ensure that we always take initiatives and make innovations in food delivery business to drive the long-term industry trend.

We have demonstrated that the potential of these markets, the path to profitability of our business model and the power of our delivery network. However, the whole industry is still at very early stage, and we plan to continue to make investment in many areas, such as supply-side operations, and further increase to our delivery capacity to drive the industry growth and solidify our long-term leading position.

Overall, we will keep our ROI-oriented investment strategy and balance the pace of growth and unit improvement. So in summary, neither unit economics performance nor the market share gains are our goals. We are focused on doing the right things -- both in the economics and market share gains will be the results when we do the right things. Thank you.

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Operator [4]

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Our next question today comes from Eddie Leung of Bank of America.

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Eddie Leung, BofA Merrill Lynch, Research Division - MD in Equity Research and Analyst [5]

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Just a follow-up question on competition. We have got some news on your competitors doing more in the lower-tier cities. So would appreciate if you have any update on that front.

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Shaohui Chen, Meituan Dianping - CFO & Senior VP [6]

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Yes, thank you for the question. We mentioned in earlier -- previous earnings calls that the industry -- overall, the industry has transitioned into a more modest growth stage. But at the same time, you can see that during this quarter, number of transactions of our food delivery business increased more than 25% on a quarter-over-quarter basis, outpaced the industry growth. Especially we make good progress in higher-tier cities and so we gain market share there, which help us further solidify revenue shares of our 2/3 in this industry.

For your question regarding low-tier cities, the growth in our food delivery transaction in lower-tier cities outpaced that in higher-tier cities in our platform. And the majority of new transacting users come from there as well. Our overall market share in lower-tier cities remained very stable in this quarter despite our competitor launched short-term promotional campaigns in certain cities to try to improve their penetration. As we emphasized, we believe our platform has clear advantage in the user base, merchant base and in delivery services and our comprehensive services. We have also built a much stronger brand awareness in lower-tier cities. Actually, in most lower-tier cities, both Meituan and Dazhong Dianping have become right now the most popular app for their daily lives. After this quarter, we actually become more confident in our overall leading position, including our position in lower-tier cities. And we believe that the scale and service quality to both the consumer and merchants and our operating efficiency are key to our long-term market leadership. Thank you.

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Operator [7]

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Our next question comes from Grace Chen of Morgan Stanley.

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Chun Man Poon, Morgan Stanley, Research Division - Equity Analyst [8]

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This is Alex dialing in on behalf of Grace. Congratulations on the strong results. So we mentioned in the prepared remarks a milder food delivery industry growth outlook. Can management provide some color on how Meituan will counter the headwind and the mid- to longer-term growth outlook in the food delivery segment?

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Xing Wang, Meituan Dianping - Co-Founder, Chairman & CEO [9]

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Thank you, Alex. In terms of long-term growth outlook for delivery business, the urban population in China is around 850 million, and I think it's reasonable to assume each of them, on average, will have 3 meals per day. So that's 2.5 billion meals in total a day.

Now 2 players in food delivery business only penetrates less than 2% of the urban total meals. There is still a long runway for growth. We believe with the rising disposable income, increasing urbanization and lifestyle change, percentage of home booking will gradually decline as the consumers will value convenience and selections more and more.

In recent years, the rapid rise of food delivery has accelerated with this lifestyle shift and we believe this trend will continue. Everyone needs to eat and everyone wants to eat better. We believe Meituan Dianping is better positioned to capture these megatrends as we have built clear leadership on both scale, brands, creating capabilities and technology platform.

As we mentioned before in several occasions, now the industry has transitioned into a stage that growth is increasingly driven more by the increased purchase frequency than the addition to users. For our platform, the average purchase frequency of our annual transacting user was only 1/5 of the top 10% consumers. There is still (inaudible) the purchase frequency.

Now supply is actually a bottleneck to the growth of purchase frequency. In the past few years, both us and our competitors focused on bringing offline restaurants online and delivery of their food to our users. However, in this new stage, we should make more efforts to make their food offerings more [adapted] to the daily needs of online food users. We need to work with the restaurant to optimize the price structure of our platform. We need to upgrade the user experience of our marketplace and improve our personalized and intelligent recommendation so that more and more new supplier can be easily found and grow our own platform.

We will also invest to make our delivery network grow and evolve with better efficiency and effectiveness to address broader mass-market demands.

So we are working on this. We don't have any major updates on this front at this moment. Before these efforts pay off, we expect the markets will continue to grow modestly in terms of number of transactions. However, we remain confident on the potential of local food delivery and we'll continue to focus on the rights things to drive long-term industry growth. I think here the key word is long term. Thank you.

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Operator [10]

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Our next question comes from Alicia Yap of Citigroup.

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Alicia Yap, Citigroup Inc, Research Division - MD and Head of Pan-Asia Internet Research [11]

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Congratulations on the very strong results. I have follow-up questions on the unit economics for the food delivery business. So given this strong improvement in gross margin, and I think you also mentioned we'll continue to invest, so how should we think about if you can elaborate a little bit the economics for the second quarter, and then how should we think about the seasonal patterns in the third and fourth quarter, especially on the demand and the order value as well as the rider costs and the promotional initiative, and how should we think about that on the margin level and also the unit economics in the second half?

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Shaohui Chen, Meituan Dianping - CFO & Senior VP [12]

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Compared to both Q2 2018 and the Q1 2019, our unit economics for food delivery improved remarkably. This is mainly due to the decrease of delivery cost per rider, which decreased by about 6% on a year-over-year basis and about 12% on a quarter-over-quarter basis. From a year-over-year perspective, this decrease came from economy of scale and operating efficiency improvement. And on quarter-over-quarter basis, we benefit from favorable seasonality.

In last earnings call, we explained about the different seasonality for food delivery, and therefore, this quarter, weather conditions were good across the country and supply of delivery riders was sufficient which gave us more flexibility to minimize incentives to delivery riders and optimize the total delivery cost.

In terms of their seasonality in the second half, for order volumes, Q3 were -- in Q3, usually a good season, as hot weather and the summer holidays provided more food delivery consumption scenarios. However, the delivery cost per order in Q3 were increased as we need to incentivize our delivery riders to work more efficiently under very hot weather conditions. And then for Q4, it is expected to be relatively softer in order volume and food delivery order gross rate will usually fall in Q4 as compared to Q3.

Also, during the winter, the cold weather conditions, some incentives will also be needed for delivery riders. So overall speaking, Q2 is usually the best season for food delivery because the weather is not yet getting too hot and also not too cold in most other areas. That's one of the important reason that we achieved good profitability. Therefore, we always suggest investors to focus on year-over-year comparison to better understand the progress of our food delivery business.

And as Xing mentioned, we still -- we firmly believe that food delivery is still in its early stage of the overall industry growth. While we have achieved that big volume in the last few years and we have seen the growth rate slowing down, we still believe food delivery will continue to contribute a bigger portion of overall urban population's food consumption, overall meal consumption. And there are lots of things that we believe we could do and the industry will evolve to continue support the growth and to meet the demand. And it's likely that we will continue to make investment in food delivery business during the rest of the year and in the following years as well when we see the ROI mid-term target. So we want to emphasize that I think growth rather than profitability is our top priority for food delivery. Thank you.

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Operator [13]

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Our next question comes from Alex Yao of JPMorgan.

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Alex C. Yao, JP Morgan Chase & Co, Research Division - Head of Asia Internet and New Media Research [14]

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Congratulations on a fantastic quarter. So my question is on the margins, now that you guys have achieved significant improvement in margin for both food delivery and group level, will that change your investment strategy in the coming quarters or the next couple of years? And how should we think about the margin trends?

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Shaohui Chen, Meituan Dianping - CFO & Senior VP [15]

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Thank you, Alex. So overall, I think this seasonal profitability does not change our overall strategy in that we still focus on growing our platform and leverage technology to drive the growth of the platform, and we always are proactive and dynamic on strategic view in terms of managing our operating efficiency and making investment for further growth.

And in this quarter, the overall margin profile is good. That is through a couple of reasons we mentioned before, food delivery turning positive for the first time and we also enjoy good seasonality that benefited the overall platform. But we think that the more important is through this quarter and together with the performance in our last few quarters, we demonstrate to the market that as a very unique platform for daily consumption, we have clear path to profitability, both for our food delivery business model and our overall platform. And we have the clear execution capability and operating capability to improve our overall profitability when we see the overall ROI is in line with our targets.

Also, we continue seeing the solidified market position of our platform now provides us more flexibility to balance growth and profitability. When we say more, on certain macro environment and more dynamic competitive environment.

So our core business is food delivery and then in-store even though they are relatively more mature and reached the market scale, we still believe there are lots of things to be invested to drive future growth, both on consumer side and on merchant side and also across the whole ecosystem.

You also noticed that we continue to invest in our R&D and in our overall marketplace capabilities to continue to improve our user experience. For our new initiative, we have seen focused or optimized operation in the last few quarters and to narrow loss and also to prioritize our results across different new businesses.

One of the major reasons for this quarter's improvement is the increased integration of our bike-sharing business and the scale back of strategy for our car-hailing business. But we continue to be very excited for our new initiatives because they present broad unmet need in the overall e-commerce for services space. It is likely that we will increase our investment and 1 or 2 or more new initiative, we'll see an ROI and we very -- we stick to our mission where people eat better and live better. So we will try our best to provide consumer more convenient local services and also provide our merchants more comprehensive marketing operational tool. So we will remain very alert in the industry trends and new opportunities, and we will make investments where we need. Thank you.

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Operator [16]

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Our next question comes from Kenneth Fong of Credit Suisse.

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K.C. Fong, Crédit Suisse AG, Research Division - Regional Head of Gaming & Lodging Research and Director [17]

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Congrats on the very strong set of results. I have a question mainly on the in-store business part. So over the past 2 quarter, we continue to see very healthy growth for the in-store business segment, up consistently 40% year-over-year over the past 2 quarters. So could you please share more details on the potential growth potential for the dining and other local service business in term of the penetration rate right now, the active merchant growth in the future as well as the average order value size growth? And also in the addition to the dining and beauty segment, what are the other potential like service categories that you see as a big potential driver going forward in the future?

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Xing Wang, Meituan Dianping - Co-Founder, Chairman & CEO [18]

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Thank you, Kenneth. I believe we have built quite a unique online platform business for offline merchants, and this business model has a very high energy area. Excluding hotel booking, our in-store business has only penetrated less than 2 million annual active merchants. So we will continue to grow our active merchant base as we deepen penetrations in existing categories and expand into new service categories. Essentially, we will improve sales efficiency and seek for more opportunities to cover those regional merchants in lower-tier cities.

We will also expand the coverage and optimize the efficiency of our direct sales team for service categories that have high growth potential. In terms of transaction-based product, our average order value, they will be increased more than 10% in this year on a year-over-year basis. We will continue to develop more transaction-based projects and enhance our operation capability to meet the ever-changing needs from consumers and merchants. We will have ample room to increase the number of active merchants paying for our advertising products.

In addition, our pool of our active merchants are also expected to be further expanded driven by the diversification of advertising product. The revenue from more developed service categories such as beauty, leisure, entertainment continued to deliver healthy year-over-year revenue growth. And newly developed categories, such as medical aesthetics application, parent and child, home decoration, et cetera are expected to be the next growth drivers for our in-store business.

For example, due to the rapid industry growth, the average revenue from our medical aesthetics category continues to grow more than 170% year-over-year in last quarter. Then we also expect parent and child services category will grow rapidly and through the related activities one of the fastest-growing service categories in China. Essentially, parent and child and other less-developed service categories have huge room to increase direct sales geographic coverage. And overall, we are still at early stage to cover more and more local services categories and merchants. Thank you.

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Operator [19]

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Our next question today comes from David Dai of Bernstein.

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Hao Dai, Sanford C. Bernstein & Co., LLC., Research Division - Research Analyst [20]

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Congratulations on a fantastic set of results. I just have a question on your advertising business. We have seen continuous pressure from macro on other advertising platforms, online advertising platforms. Do you also face a headwind and do you have unique advantages to counter it?

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Xing Wang, Meituan Dianping - Co-Founder, Chairman & CEO [21]

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Okay. So as we mentioned before, consumer staples such as food consumption generally remained resilient against macro headwinds. We believe that our food delivery services have a high frequency and relatively low ticket-size nature, and therefore, are less impacted by short-term macro slow down.

In terms of our advertising revenue, traditional online advertising platform have meaningful portion of key account customers from verticals like FMCG, hotels, real estate and other consumer sectors with large ticket size. And they typically focus on targeting consumers in higher-tier cities. Macro softness will negatively affect these platforms as consumption on these categories will decrease remarkably. Our advertising revenue continued to have a healthy growth in the past several quarters despite the weak macro condition mainly due to our focus on foods than other services. Consumptions of these lifestyle services continue to rise.

In addition, we have a lot of small local merchants on our platform who have not fully utilized their marketing budget yet due to the high bidding price on other platforms. Therefore, as we offer compelling ROI and affordable cost and larger consumer base with a strong searching engine, we will be able to unleash the potential [of decreasing] the unmet marketing needs. We are still at the early stage of renting up our apps business and have a big potential to further penetrate it into new merchants from both existing and new categories.

In online marketing space, there are several things that differentiate us. We have leading location-based algorithms which lead to better search results. We leverage the local queries and our leading location-based algorithms to connect consumers with merchants and providing users more customized search results and merchants high ROI of their marketing spending.

For consumers, we are the only platform with a blend of authentic user-generated reviews for millions of local service merchants. For merchants, as we are focusing on local services and when users open our app, they have a clear intention embedded in search queries. We generate the higher click-through rates and commercial rates for [apps]. This advanced location-based service technology platform with unrivaled leadership in user base, merchant base and high quality user generated content, give us a unique advantage for online advertising. Thank you.

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Operator [22]

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And our next question today comes from Jerry Liu of UBS.

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Yuan Liu, UBS Investment Bank, Research Division - Co Head of HK and China Internet Research [23]

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Yes, I wanted to ask about travel, in particular the performance of the hotel business. In the prepared remarks, we talked about the new Hotel+ X program, cross selling to the high-end hotels. So it sounds like we're putting some more resources into this area and talking more about it now. So I just want to get a sense do we believe that we can continue to gain shares in hotels? Like can we get an update on what's the long-term strategy here?

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Shaohui Chen, Meituan Dianping - CFO & Senior VP [24]

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Yes, sure. We are very excited for the hotel business in our platform. Besides the continued strong growth, we also see our ADR per room night experienced a steady year-over-year growth and high star hotels contribute a higher percentage of total domestic room nights in Q2 on a year-over-year basis.

We also continue to enhance the cross-sale capability. This is a very differentiated capability we have from traditional OTA, and we think this provides strong foundation for us to further grow business and gain market share in the overall online hotel booking business.

Right now about now 90% of new transaction users for our hotel booking business are already existing users of our food delivery or in-store dining business. So we have a much better cost structure and operating leverage compared to OTA.

We have also seen very good progress move into higher tier from their -- with the natural growth of the disposable income of our younger generation consumers.

In addition, we continue to help hotels, especially mid to high-end hotels, further expand and increase their revenue streams in non-lodging services. I think this is very well received by these hotels and become very important new revenue drivers.

Our performance further demonstrate very efficient ROIs of our hotel business and we think it's a good timing for us to further increase our investment in the hotel space. So we plan to increase overall investment in hotel space during the rest of year. In the mid- to long-term, we think this business has very good potential for sustainable growth and for very good margin profile. But the current timing, we prioritize long-term growth rather than profitability in a hotel business.

So you should expect to see -- reallocate more resources in the hotel business particularly the domestic hotel room night growth and including both the lower-tier cities and mid- to high-tier cities. Hotel booking business has clear strategic value for us and it's also a very good example to demonstrate our platform advantage. So we will continue to invest and grow this business. Thank you.

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Operator [25]

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Our next question today comes from Natalie Wu of CICC.

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Yue Wu, China International Capital Corporation Limited, Research Division - Analyst [26]

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Congratulations on very solid result. You mentioned before that you will keep prioritizing resources across different lines of new initiatives. Can you share more details on the current priority of your investment in the second half of this year, and what kind of scale should we anticipate, respectively? Also, can you share with us the process of your 2B new initiatives? More particularly, would love to hear management's thoughts on the largest challenges you've encountered when you are promoting your RMS currently.

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Xing Wang, Meituan Dianping - Co-Founder, Chairman & CEO [27]

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Thank you, Natalie. So yes, we have a lot of new initiatives, so a lot of stuff in that segment. For our RMS, the Restaurant Management System and food distribution service, in the first quarter -- in the first half, were mainly focused on improving our merchant base and product offerings, service quality, operating capabilities and team structure because you need to have the right team in place to build the business and it takes time. And in fact, the percentage of high-quality merchants with annual sales above certain thresholds increased steadily in the first half. And because there are millions of merchants out there, you need to do the STP, the segmentation, targeting and positioning. So now we want to target the higher-quality merchants. And this should lay a better foundation for future monetization of these 2B businesses. Both RMS and food distribution service have clear strategic value to our platform and are the important parts of food service value chain. And they could help our merchants improve operating efficiency and customer satisfaction and reduce management hassles. And we will continue our investment in these 2B services in the second half and we will continue to improve operating efficiency and iterate our business model based on latest industry trends and our learnings from practice.

In addition to that, we will also actively explore additional opportunities in other 2C services such grocery retail, which has a huge total addressable market, low online penetration. Currently, online growth in retail industry is still at a very early stage with a few industry player exploring different types of business, and all kinds of people are trying all kind ways and those big operations and very well-funded start-ups; and no one knows what really is working. So yes, we're trying. And there a lot of attempts, but none of this business models have yet proven to be successful. At this time, we did not no rush to scale up. Our objective is to test, to verify and iterate our grocery retail business model. Once -- only after we are confident that we have the right model, we will invest heavily to scale up. And so once again, I want to emphasize that we will be more disciplined when allocating capital for new initiative. And we will prudently evaluate the ROI for long-term perspective. Again, here the keyword is long term.

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Operator [28]

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And ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to [Scarlett Yu] for any closing remarks.

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Unidentified Company Representative, [29]

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Okay. Thank you, everyone, for joining our call. We look forward to speaking with you next quarter. Thanks a lot.

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Operator [30]

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Thank you. Today's conference has now concluded, and we thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.