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Edited Transcript of QTT.OQ earnings conference call or presentation 3-Dec-19 1:00pm GMT

Q3 2019 Qutoutiao Inc Earnings Call

Dec 5, 2019 (Thomson StreetEvents) -- Edited Transcript of Qutoutiao Inc earnings conference call or presentation Tuesday, December 3, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Xiaolu Zhu

Qutoutiao Inc. - Co-CFO

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Conference Call Participants

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* Alicia Yap

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

* Mon Han Chung

KeyBanc Capital Markets Inc., Research Division - Research Analyst

* Zhijing Liu

UBS Investment Bank, Research Division - Associate Director and Research Analyst

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Presentation

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Operator [1]

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Hello, ladies and gentlemen. Thank you for standing by, and welcome to the Third Quarter 2019 Earnings Conference Call for Qutoutiao Inc. (Operator Instructions) Today's conference call is being recorded.

I will now turn the call over to your host,

[Saiqi Lu]. Please go ahead, Sir.

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Unidentified Company Representative [2]

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Thank you very much. Welcome, everyone, to the third quarter of 2019 earnings conference call of Qutoutiao, Inc.

The company's financial and operational results will be -- were released by Newswire services earlier today and have been made available online. You can also view the earnings press release by visiting the IR Section of our website at ir.qutoutiao.net.

Participants on today's call will include our CEO, Mr. Eric Tan; and our Co-CFOs, Mr. Jingbo Wang and Mr. Xiaolu Zhu.

Before we continue, please note that today's discussion will contain forward-looking statements made under the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties.

As such, the company's results may be materially different from the views expressed today. Further information regarding these and other risks and uncertainties is included in the company's prospectus and other public filings as filed with the U.S. Securities and Exchange Commission. The company does not assume any obligation to update any forward-looking statements, except as required under applicable law.

Please note that Qutoutiao's earnings press release and this conference call include discussions of unaudited GAAP financial measures as well as unaudited non-GAAP financial measures. Qutoutiao's press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited GAAP measures.

I will start by reading out Eric's commentary on the business.

I would like to first review the business for the third quarter and then provide some outlook for the last remaining quarter of the year and further beyond. For the review part, I will go through the key highlights in growth, content, user economics before touching on Midu's development in a bit more detail. Despite the less than hospitable operating environment which has persisted for much of the year, we have pushed on with determination as well as agility.

Our DAU has reached to 42 million, which has doubled from the level a year ago, while our MAU has also shown a similar leap. While irrational competition early in the year and a weak advertising market have caused some impact on our growth trajectory, neither has dented our core capabilities, and we have taken advantage of the slower market to not only initiate organizational improvement and invest in our people and technology, we have also made meaningful progress on product suite expansion. The most notable of which is Midu Lite, which commenced in May and has quickly gathered more than 3 million DAU.

To further strengthen our competitive advantage, we continue to build our content ecosystem, both for Midu and QTT. During the third quarter, we expanded and deepened our cooperation with content producers, most notably, iReader, also known as Zhangyue, which is currently the largest single online literature platform in China. Our users will be able to enjoy both quality content coming from iReader as well as the personalized and enhanced reading experience facilitated by our AI platform.

On the QTT side, we have further made efforts to upgrade our content curation by establishing permanent connection to the public ID verification system of the police department, which allows our platform to automatically screen out the ineligible acounts.

The result has been a termination of more than 10,000 content provider accounts since July, and a significant reduction of negative feedback of users. Additionally, there have been targeted initiatives aiming at strengthening content offerings for specific categories, such as games, dancing in public squares, health, entertainment, news, et cetera.

Through our collaboration with prominent media groups in the entertainment space, we are signing up celebrities as content contributors. Our users will continue to enjoy the progress in our content offerings in terms of both richness and quality. Content improvement is a key ingredient for better user retention and monetization. Both of our short-term and long-term retention rate in the current quarter are at least 10% better, in relative terms, in comparison to the first half of this year, consistent with the trend of rising time spent observed in the quarter.

ARPU trends have been muddied by the temporary suspension of Midu Novels. But if we look at QTT on a stand-alone basis, there has been clearly a sequential improvement. Diversification of revenue streams is also progressing nicely with revenues generated from games and live streaming, both more than doubled quarter-on-quarter. We now have 10% to 20% of our users accessing games and around 3% of users active on live streaming on a daily basis.

The significance of diversification is not just enhanced monetization potential, but also an expansion and enrichment of the overall Qutoutiao ecosystem. It's actually becoming more relevant and indispensable for more people over time, and this is putting the synergy lever to improve long-term retention rates and grow user time spend. Being able to structurally increase retention, both at the long and the short end, gives us confidence that we are pushing in the right direction.

We're also stepping up the monetization efficiency of our proprietary advertising platform by transitioning into an OCPC system, which is supported by strong AI and data capabilities as well as close partnerships with our customers, built on mutual trust and our consistent delivery of value-added services.

In comparison to the traditional CPC system, it has the benefit of further de-risking advertising [customers-budgeting process] by offering more precise and tailored traffic allocations, taking into account customers' overall return requirements. This allows customers to increase spending with even better results and allows us to accelerate the evolution of our ad tech. As we keep optimizing the process, enhancing our core competitive advantage and deepening our client relationships over time.

With better retention, a stronger monetization engine, and ARPU improving, we shall see better ROI driving our business goals going forward.

Now on Midu. As you know, for the most part of the third quarter, commercialization and content upgrade have been suspended for Midu Novels. However, Midu Lite, driven by superior user economics even at this early stage of development has quickly grown to become a strategically important pillar of the Midu franchise.

As the differentiated design, which incorporates a loyalty program in addition to the standard offer of Midu Novels is inviting many who have zero experience with online literature to give it a try, and consequently developed a passion for reading. Our data support this observation as the overlap between Midu Novels and Midu Lite is negligible despite them both being of reasonable size already as we speak. Given the highly complementary nature of the 2 apps in relation to each other. We will promote them equally going forward as together, they allow us to more effectively target both the existing reading population and potential reading population, achieving full coverage of the entire market from a product perspective.

The broader significance of this development is that it will lead to an acceleration in the inevitable structural shift of the industry from a paid-only model to ultimately a freemium model, as the availability of the right offerings will quicken the popularization of the free-to-read concept and the awakening of the potentially huge demand from the addressable market, still largely unaddressed.

Despite going through a tough period recently, Midu received a round of financing led by CMC Capital Partners, which is a recognition of the solid fundamentals of the business and its long-term growth potential. And we are grateful for CMC's support and trust.

Our target is to become the largest online literature platform in China in the next quarter or 2 with more than 10 million DAU. From which point onwards, we will increasingly gain brand value in the minds of both content providers and readers, feeding a virtuous cycle of ever-expanding content library, user base and monetization potential, which will further strengthen our leadership position in the industry.

Finally, in terms of the outlook for the future, we firmly believe that the lower tier cities remain the most attractive space today with unmatched structural potential for growth and monetization.

One notable fact that has come to my attention recently, which I would like to share, is that during the Double 11 Shopping Festival. GMV's generated by Qutoutiao users on e-commerce platforms increased more than tenfold in comparison to last year. We are in a privileged job of serving a huge historically underserved population, and we certainly intend to more than keep up with that -- with what our loyal users at Qutoutiao's.

Our priority is not simply growth, but rather long-term profitable growth. We intend to respond to market fluctuations with reason and gain comfort in remaining focused on doing the right things that will ultimately matter. That means a balanced approach to growth and capital allocation, with an emphasis on sustainability. Thank you very much.

That concludes Eric's remarks, and I will now read our CFO's comments.

We generated RMB 1.4 billion revenues in the third quarter of 2019, which is an increase of 44% in comparison to the same period last year. Sequentially, revenues are up slightly, not fully reflecting the underlying improvement in the business and the overall market as we experienced, mainly due to the loss of revenues from Midu Novels as a result of the 3-month suspension between mid-July and mid-October.

The suspension has now been fully lifted, but we are not in a rush to ramp up growth yet as we have been taking the opportunity to refine our product design, recalibrate our longer-term strategy. We expect some time before Midu's revenue fully normalized.

Our ARPU, which is defined as revenue per DAU per day, was RMB 0.36 in Q3 2019 compared to RMB 0.39 in Q2 2019 and RMB 0.51 in Q3 2018. The year-on-year decline has been driven by the general weakness of the advertising market this year as well as the loss of revenues due to Midu Novels suspension. Sequentially, however, we have seen growth on a like-for-like basis, consistent with seasonal tailwinds and a structural improvement in our ability to monetize.

Turning to costs. I will focus on non-GAAP measures, which excludes stock-based compensation. For Q3 2019, our gross margin was 65% compared to 84% in Q3 2018. The decrease was due to 3 factors. Firstly, there was the loss of revenues from Midu Novels, which was not commensurate with the amount of savings on the content cost side. Secondly, there was a negative mix impact from the growth of the low margin, integrated and customized Marketing solutions services.

Thirdly, we have increased investment in content and IT infrastructure to support the increasing richness of our content as demonstrated by the rising share of videos, games and live streaming in our user's consumption mix.

Our user engagement expense on a per DAU per day basis have almost halved from RMB 0.25 a year ago to now RMB 0.14. We intend to keep it at close to this level for the near future, given the material reduction achieved in a relatively short period of time. Core to what has made this possible is the enhanced value proposition of our products as well as the result of our ongoing investment into our content, technology and people.

As a percentage of revenues, user engagement expenses were 38%, which was 11 percentage points lower in comparison to last year, despite the temporarily suppressed revenue base we endured during the quarter. Our user acquisition expenses were RMB 6.58 per installation, which was 5% lower quarter-on-quarter, as we benefited from the generally weaker advertising prices in the market. As Midu Lite has grown rapidly during the period, which required investment to support use acquisition, our overall spending in absolute amount in this area has stayed flat sequentially.

Other sales and marketing expenses were 12% of revenues, which was higher year-on-year due to the temporary reduced revenue base as well as our increased spending in brand advertising.

We believe that given our current scale and leading position in the industry, brand campaign is a sensible additional marketing strategy as increasing awareness of our name should encourage natural inflows of users and potentially word-of-mouth effect, which can accelerate such natural traffic.

R&D expenses were 16% of revenues in the quarter, which was generally in line with Q2 2019 and higher than the 7% in the same period last year, again, to a certain extent, affected by our suppressed revenues, in addition to our increased capital allocation to technology and talent.

G&A expenses were 4% of revenues in the quarter, generally in line with history. Overall, our non-GAAP net loss was RMB 833 million, representing a net loss ratio of 59%, which was increased from a year ago, largely reflecting the impact from the suspension of Midu Novels and investment required by the fast-growing Midu Lite and to a lesser extent, our investment in IT infrastructure.

This quarter, we have also completed the issuance of new shares to the paper, also known as (foreign language). Pursuant to the agreement, we entered into before our IPO. More details of this transaction can be found in our most recent Form F-3 filed mainly for the purpose of this transaction.

Our balance sheet remains strong with RMB 2.1 billion cash as of September 30, and we remain confident that we are well supported to continue to grow and invest for the future.

As Eric has already discussed, we would like to take a more balanced approach between growth and profitability going forward. Our most mature and biggest business line, QTT, has already seen a healthy uptick in operating margin in the second half of 2019. With its strong performance so far in the fourth quarter, we now expect this business line to breakeven in 2020 on a stand-alone basis.

Now for the fourth quarter, we are seeing better unit economics as a result of better user retention as well as better ARPU on the QTT side, which we believe will be sustained throughout the fourth quarter and beyond.

Together with better economics, we expect our margin for the entire company in Q4 to also recover a level better than what we achieved in the second quarter of this year.

For Q4 revenue guidance, based on our view of the market and the operating conditions, which are subject to change. We expect net revenues to be in the range of RMB 1.6 billion to RMB 1.62 billion. This has taken into account the resumption of normal operations of Midu Novels for the latter half of the quarter.

That concludes our prepared remarks today, and now we are open for questions.

Operator, please proceed.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

We have the first question, coming from line of Zhijing Liu from UBS.

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Zhijing Liu, UBS Investment Bank, Research Division - Associate Director and Research Analyst [2]

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(foreign language)

Let me translate myself. I have 2 questions. The first one is we see COGS in Q3 had a surge of over 200%. The official explanation is QTT have a newly integrated and customized marketing solutions services.

Can you introduce this new business, and the reason for integration? The second one is how do you look at the competition of free-reading market or competitors like (inaudible) and Feedly had a quite good momentum as we do it, just to have a new round of financing, will you guys maintain your marketing and user acquisition at a high level?

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Xiaolu Zhu, Qutoutiao Inc. - Co-CFO [3]

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Zhijing Liu, this is Xiaolu. Regarding your first question, in terms of gross margin, I think it's a combination of several factors, especially if you look at the year-over-year numbers. The #1 factor is, obviously, the loss of revenue from Midu.

This loss of revenue has skewed our margin across line in Q3. The second reason is content cost on the Midu side. As there are certain upfront payments for working with content providers like iReader. We make our investment decisions based on the normal cost of our business, and the suspension of Midu came as a surprise to us, but we choose to not interrupt the normal operation of our business, given the lack of time for preparation and notice. So we continued the content expenditures in Q3.

The third reason is additional costs associated with content compliance. This is something that we have put in a lot of efforts so far this year. But I think this part of cost should be stable going forward. The fourth reason is that, as you mentioned, there's a small amount of our revenue in Q3 have a lower gross margin. This is the news that we start to provide to our third-party partners for general advertising platform services.

This is still a small part, and we don't think this will be a big part of our revenue going forward. The fifth reason is a change of user preference, especially in the content format side. Now more videos are being viewed every day by our users. The majority -- over 50% of our advertising are delivered through video, which means that it requires more infrastructure buildup such as servers and bandwidth and also different AI computing resources.

So I think the decrease in gross margin this quarter is a combination of several factors as I just explained. And the biggest problem is the loss of revenue from Midu in Q3.

So we believe that our gross margin will be back to over 70% in Q4 and beyond as the impact of the Midu suspension is smaller in Q4 compared to Q3. And also if you look -- going forward, I think there will be more leverage. Content cost as a percentage of revenue will decrease as Midu's revenue increase. IT infrastructure-related costs should be stable and content compliance costs should be stable as well. So overall, I think, for the next year, we will see gross margin over 75%.

So your second question regarding the competition of Midu, I think, despite the suspension in Q3, we continue to be the #1 player in the free online literature market, with comfortable margin based on third-party data we have seen.

Our goal to become the #1 player in the entire online literature market has not changed, essentially with the launch of Midu Lite, we were able to keep our combined user traffic to be stable for the entire Q3. So our -- the combined DAU of Midu and the Midu Lite is still over 8 million as of now. The other thing is that with the additional royalty of feature of Midu Lite, the new app attracts somewhat different user base compared to the original Midu app.

And also with this royalty program, we are able to increase the ARPU of Midu in Q4. So combined, these -- the 2 apps now contribute to -- close to RMB 3 million per day in terms of revenue for the first week of December. And we see a continued clear path towards profitability for -- especially on the Midu Lite side with higher ARPU next year. Also, overall, the user overlap between Midu and Midu Lite is very small at around 2%. Midu Lite is able to attract users new to online literature because of its loyalty feature. So we believe both apps has a long-term strategic value for us, and we believe it will help us to capture a bigger share of the market. Thank you.

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Operator [4]

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We will move to the next question now. The next one comes from Alicia Yap.

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Alicia Yap, Citigroup Inc, Research Division - MD and Head of Pan-Asia Internet Research [5]

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(foreign language) I have 2 questions. The first one is related to the softness for the fourth quarter guidance. So I understand that is -- a partial of it is related to the Midu, as revenue have been rebounding, maybe taking a bit slower. So just wanted to get a bit more sense in terms -- into next year, how should we think about the 4Q guidance indicated for -- as we go into 2020. Should we expect the revenue growth rate could reaccelerate in the latter half of 2020 as we lap up this difficult comp.

The second question is a little bit follow-up on the competitive landscape on the free reading app. So I think just now management did already mentioned quite a bit of the strategy, the differentiation. But just wanted to get a bit more color in terms of the differentiation between the apps. Like what could be the attractive point for the user to come to Midu app versus other free reading apps out there. So what are the special criteria or the special attractive points that Midu app have that other competitors doesn't have that allow us to attract the user? (foreign language)

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Xiaolu Zhu, Qutoutiao Inc. - Co-CFO [6]

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No. Thank you, Alicia. I think regarding your first question. Yes, I think -- I mean it took some time for the Midu app to get back into full steam after the end of the suspension. As I already said, right now the run rate at RMB 2.5 million to RMB 3 million per day. So I would say that for December, we have had Midu back. But in the early part of Q4, yes, we did have some impact from the previous suspension and which suppressed the revenue from Midu. But overall, I think we have seen a very strong performance especially in the second half of Q4.

On the QTT side, we see continued growth with new features, including short video, live streaming, leisure games, all contributing. As of today, I think 70% of our users already played some video games on QTT without us making any big promotions. And our game publishing and live streaming is already starting to provide new monetization channels for us.

In Q4, the contribution from these channels are still in the low single digits in terms of estimated total revenue, but they are ramping up very quickly. With better monetization comes better ROI. I think over the longer term, this will allow us to invest for more future growth. So combined, we continue to see very healthy growth in Q4 2019. But, however, as discussed in the prepared remarks, overall, we will make a more balanced approach between growth and profitability. We now see a much clearer path towards profitability in 2020. Especially on the QTT side, we believe with disciplined expense control, QTT, on a stand-alone basis, will be able to achieve breakeven on a quarterly basis in the second half of 2020, and if we do it well for the entire company as well. So starting on this quarter, we are taking a more stringent approach in terms of user acquisition. As now all our new investment for user acquisition needs to meet the 6 month's payback period threshold, which means that we ask our team to get our initial investment back within 6 months. This is a much stringent requirement compared to our previous quarters.

So unless we see real compelling new opportunities, we will stick to the current plan and to put more focus, sustainability and the long-term profitable growth in Q4 and beyond. As to your question regarding next year, especially second half of next year, given the loss of revenue in Q3 for Midu, I think, on a like-for-like basis, next year second half, we probably will see accelerated growth. And also, if we do things right, we'll be able to reinvest the profit back into the business in the second half of 2020.

But overall, I think we will take a balanced approach. So the health of the business and the long term sustainability, first, then there will, naturally, come with the growth.

Regarding your second question, the competition with other players in the online literature market. I think we have this Midu and Midu Lite one-two punch. We'll able to cover last user base, especially in the lower tier cities. In terms of a content library, as we have discussed in our prepared remarks, we have signed -- basically, every big, major content providers other than China Literature in the market, especially our cooperation with iReader is very comprehensive. So we do have the most comprehensive content library in the market as of now. Our second advantage is our data and algorithms. So from our experience as a new speed provider, we're able to match our users' interest with most precise content.

The third thing is that this loyalty program we have on the Midu Lite side, which allows us to attract a different user base, especially users new to the online literature content. And I think with these 3 factors combined, we'll be able to continue to lead in this market. Thank you.

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Operator [7]

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(Operator Instructions)

We have the next one coming from the line of Hans Chung.

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Mon Han Chung, KeyBanc Capital Markets Inc., Research Division - Research Analyst [8]

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So just a quick question regarding the fourth quarter. Can management give more color around the key assumption of -- on the user metrics, for example, like the MAU, DAU and then on both the QTT and the Midu? And also what's the ARPU trend on the sequential basis? And then perhaps the -- our view on the cost side? Or what will be the operating loss for the fourth quarter?

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Xiaolu Zhu, Qutoutiao Inc. - Co-CFO [9]

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Sure. I think for the fourth quarter, as I said, we will -- we plan to take a balanced approach. So this will -- this means that we will prefer a long-term sustainable growth. And as I said, we will take a more stringent approach in terms of user acquisition.

So I think for Q4, we'll probably see a slower user base increase compared to our previous couple of quarters. In terms of ARPU, on the QTT side, the ARPU trend is already quite strong, especially for Q3 and so far in Q4. On the Midu side, with the back to normal operations, the ARPU for Midu is -- obviously, will be better compared to Q3.

So overall, I think we'll see a slight increase in terms of traffic, better ARPU and overall, we'll see a sequential increase in terms of revenue from Q2 and Q3. And in terms of bottom line, I think with a more disciplined approach in terms of investment, we will see better margins in Q4 as well. For now, I think we believe that the Q4 loss will be smaller compared to Q2 in terms both of absolute dollar amount and also in terms of margins.

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Operator [10]

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We have the next question coming on the line of

[Vamos Chongo]

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Unidentified Analyst [11]

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I would like to ask about the long-term KPI for a company, in particular, how should we think about the revenue per DAU over the long term. And also, how should we think about the daily-active users in the long term, do we have any KPI about our 3-year plan? (foreign language)

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Xiaolu Zhu, Qutoutiao Inc. - Co-CFO [12]

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So in terms of ARPU, I think, this year, we have seen some less than hospitable operating environment, especially under the macro headwind. So if you look at our ARPU this year and compared to last year, I believe that in the second half last year, our ARPU was over RMB 0. 45. To be more specific, RMB 0.50 in Q3 and RMB 0.47 in Q4 in 2018. So I think it's possible that we can get our ARPU back to that level somewhere down the road. But I think it will take some time, and it will also depend on the overall economic landscape in China as well.

In terms of total user base, I think we still believe that lower tier cities remain the most attractive space today with unmatched structural potential for growth and monetization. However, as I said, we want to take a more balanced approach regarding growth and profitability down the road. So I think we still have a high expectation for the long-term DAU and MAU target, but I think we now will probably pace our growth together with profitability. Thank you.

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Operator [13]

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As there are no further questions. Now I'd like to turn the conference call back to the company for any closing remarks.

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Unidentified Company Representative [14]

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Thank you very much for joining today's call. And please don't hesitate to reach out to our Investor Relations team for any further questions.

That concludes today's call. Thank you.

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Operator [15]

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Thank you, ladies and gentlemen. That concludes our conference call for today. Thank you all for your participation. (inaudible) Good day.