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Qutoutiao Inc. (QTT) Q1 2019 Earnings Call Transcript

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Qutoutiao Inc. (NASDAQ: QTT)
Q1 2019 Earnings Call
May 20, 2019, 9:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Hello, ladies and gentlemen. Thank you for standing by for the first quarter 2019 earnings conference call for Qutoutiao Inc. At this time, all participants are in a listen-only mode. After management's remarks, there will be a question and answer session. Today's conference call is being recorded.

I will now turn the call over to your host, Fionna Chen. Thank you. Please go ahead, Fionna.

Fionna Chen -- Director of Investor Relations 

Thank you. Hello, everyone and welcome to the first quarter 2019 earnings conference call of Qutoutiao Inc. The company's financial and operational results were issued via newswire services earlier today and are 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 Mr. Eric Tan, our Co-Founder, Chief Executive Chairman, Mr. Jingbo Wang, our Co-Chief Financial Officer, and Mr. Xiaolu Zhu, our Co-Chief Financial Officer.

Before we continue, please note that today's discussion will contain forward-looking statements made under the safe harbor provision of the US 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.

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Further information regarding these and other risks and uncertainties is included in the company's prospectus and the other public filings with the US 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 discussion of unaudited GAAP financial information as well as unaudited and non-GAAP financial measures. Qutoutiao's press release contains a reconciliation of the unaudited and non-GAAP measures to the unaudited most directly comparable GAAP measures.

I will now turn the call over to my colleague, [inaudible], who will read prepared remarks on behalf of Mr. Tan. Please go ahead.

Eric Tan -- Co-Founder and Executive Chairman

[Through Translator] Thank you very much for joining the call. I'm very pleased to have our Chairman and CEO and our CFO, JingboWang here with us. I will read Eric's comments on the business side.

Today, I'd like to share my thoughts on three subjects -- the business, our team and organization, and strategy for the rest of the year. First of all, I will provide some updates on the business. Our business continued to grow in the first quarter of 2019 with combined average DAUs reaching 37.5 million, representing almost four-fold increase year on year. Our combined average MAUs have reached 111 million, also a four-fold increase from the same period last year. Comparing to the previous quarter, our DAU have increased to 21% and MAU increased 19%.

For Qutoutiao, the focus in the first quarter of 2019 was to enhance user experience and optimize unit economics. We kick-started our trusted sources program, which aimed at offering high-quality and reliable information on key subjects, such as health, fitness, and parenting. For example, we invited doctors from reputable institutions on to livestreaming to interact with users. We also encouraged more articles to debunk health myths.

We started a distribution partnership with UFC, the Ultimate Fighting Championship, whose content very much appealed to our male users. We opened a dedicated mini-video section to respond to the rapidly increasing user appetite for it. We will soon allow users to upload mini videos.

To improve user stickiness, we have added social features to our application, such as following and tipping. We further reduced user engagement expenses on a per DAU per day basis without much impact on user stickiness and retention, which shows that our users stay for the right content and not so much for the momentary reward.

Given the first quarter is a low season for our pool, we made the conscious decision to reduce the volume of user acquisition, although this means that user growth would slow in the short-term, it benefits the company from an ROI perspective.

Moving on to Midu, based on mobile data, Midu has consistently ranked number one in free literature apps in terms of DAU and was getting very close to top paid for literature apps as of the end of April 2019. To enhance the value proposition of Midu, we established a strong in-house editor team and will soon launch a proprietary platform to work directly with writers to produce original content. AI has played an important part in the success of Midu by dynamically recommending books to users and helping them explore new titles and genres. AI has been key to better using engagement and retention.

In terms of new products, we have been testing a short video act for a few months. It has reached more than a million views and user engagement and retention data have been promising. We are looking to further optimize the product and promote it to the wider market in the coming months. Ecommerce-wise, we have been exploring collaboration opportunities with Taobao, Alipay, and JV, and are conducting feasibility tests. We are optimistic that over time, it will make a meaningful contribution to the bottom line by either becoming a new revenue stream or if we let users exchange loyalty points for goods, it will reduce our engagement expenses.

To further diversify our monetization, we are also exploring other avenues such as casual games, livestreaming, which currently generates a small amount of revenue rapidly growing. Secondly, there have been some new developments to our management team and organizational structure. My partner, Let Li, has resigned from the CEO position and will take on the new role of Vice Chairman of the Board.

Let and I founded Qutoutiao together in June 2016 and we have worked very closely together day in and day out. Lay is a serial entrepreneur for many years and I totally understood when he said that he wanted to spend more time with his family. As Vice Chairman, he will continue to provide important support and guide to the company and I'm grateful for that. I will take on the CEO position and be fully committed to leading the company through the next stage of development.

I would like to also introduce Mr. Xiaolu Zhu, our newly appointed Co-CFO. He has a wealth of experience with the capital markets and the internet industry, having held senior management positions in various leading tech companies. He will be responsible for investor relations and capital markets-related activities. Our CFO, Jingbo Wang, who is hosting this call with me today, will be responsible for the overall financial management of the group.

Our overall organization has expanded tremendously over the past two years and our headcount has grown from 200 to 2,000+ today. When a team is growing so rapidly, the biggest challenge is to maintain agility, which has been important to our competitiveness from day one. Over the past quarter, we have thoroughly gone through the various teams and structures we have and redesigned the structure. We are building a service-oriented architecture to make innovation faster and more cost-effective.

Many common functionalities are being made modular and their ongoing improvement will be leveraged by all the commercial and product units, hence avoiding reinventing the wheel and minimizing the lead time for app rollout and improvement.

We're also building full-function teams, incorporating personnel from commercial to technical so that there could be a comprehensive assessment of the task at hand, a swift decision process as to what needs to be done. This will make innovations easier, responses faster, and decisions smarter. These internal organizational initiatives are key in determining the long-term competitiveness of our company, even though it is hard to observe or to have a feel for from the outside.

Turning to strategy, in the long-run, I believe total mobile timespan is a constantly growing pie. We want to play an important part in offering people high-quality mobile information and entertainment. In the near-term, however, we're seeing some irrational competitive behaviors in the market that affect Qutoutiao.

Certain competitors are burning through a lot of cash to ramp up user base without regard to return on capital. We have chosen not to join the crowd. Instead, we will take the opportunity to push through product improvements such as enhancing content recommendations and further developing social features. Our goal is to create an information and entertainment platform that has a unique value proposition and user community, which will give us a much stronger base to drive future growth.

For Midu, the focus for the rest of the year will be building a content ecosystem and strengthening social features. We will encourage interactions between readers and also between writers and readers, such as commenting and discussing. Recently, we have also introduced a social-based user referral program to Midu, which we believe will be a valuable additional to the growth strategy of Midu at this stage. Our objective is for Midu to be the number one online literature platform by the end of the year, if not earlier.

We're also facing a lot of challenges, notably the weaker than expected advertising market. The reason excess supply coming from various companies has put a lot of pressure on pricing. We believe for us the cure is technology. As we have operated our proprietary advertising platform for only slightly more than a year, our vetting system and targeting algorithms are not as fine-tuned as the established players. But the flipside is that there is a lot of room for improvement. Recently, we have seen encouraging results and we will continue to focus on growing and optimizing our ad platform.

This concludes Eric's remarks. Now, I will read the prepared remarks from our CFO, Jingbo.

Jingbo Wang -- Co-Chief Financial Officer

[Through Translator] We generated 1.1 billion RMB revenue in the first quarter of 2019, which is typically the weak quarter of the year due to the seasonality of the advertising industry. Our e-commerce advertisers, which contribute a significant percentage of our revenues, tend to go through a quieter time. Meanwhile, our users tend to be less active and spend less time reading news and watching videos during this period into which the Chinese New Year falls. Therefore, we saw a sequential decline, which was consistent with our expectation as well as the trend we saw in the first quarter last year.

On a year over year basis, our revenues are close to five times higher, driven by DAU growth and higher RPU. Our RPU, which is defined as net revenues per DAU per day was RMB 0.33 compared to RMB 0.48 in the fourth quarter of 2018 and RMB 0.23 in the first quarter of 2018. The sequential decline was partly due to seasonal topline weakness, partly due to the faster growth of Midu and new products, which at a relatively early stage of development, have lower than average RPU.

Turning to costs and expenses, I will focus on non-GAAP financial measures, which exclude stock-based compensation. For the first quarter of 2019, our gross margin was 75.2%, which was a 2% improvement year on year, although sequentially, it has shown a contraction given a decline in topline. Our largest expense is sales and marketing, which consists of three elements, user acquisition, user engagement, and others.

On a per DAU per day basis, our user engagement expense has seen meaningful improvement, which has come down to RMB 0.17 comparing to RMB 0.20 in the fourth quarter of 2018. Among the many contributing initiatives is our individualized loyalty points mechanism, which uses AI to very the amount given to different people based on their sensitivity toward monetary reward. New products we have launched such as Midu do not offer loyalty points. So, as they grow to constitute a bigger part of the overall business, there will also be a positive mix impact. We expect to see further unit engagement cost reduction in the second quarter of 2019.

As a percentage of revenue, our user engagement costs in the first quarter of 2019 were 52% versus 81% in the first quarter of '18 and 43% in the fourth quarter of '18. Given a seasonally weaker Q1, we've dialed back user acquisition to project ROI, mainly on the Qutoutiao side, where total new installation has decreased 26% quarter on quarter.

Overall, user acquisition costs for installation were 6.21 RMB, generally flat compared to the first quarter of 2018 and lower than the RMB 6.57 in the fourth quarter of 2018. As a percent of revenue, it was 60% in the first quarter of 2019, higher than the 56% in the fourth quarter of 2018, but meaningfully improved year on year from the 65% in the first quarter of 2018.

Other sales and marketing expenses amounted to 33.8 million RMB, which was 3% of revenue compared with 4.1% revenue in the fourth quarter of 2018 and the 6.7% in the first quarter of 2018. R&D expenses were 12.4% of revenue in comparison to 8.7% in the fourth quarter of '18 and the 7.8% in the same quarter last year.

This was the result of 20% absolute sequential increase in R&D spending, as we have continued to invest in talent and our core technological capability, which are key to our long-term competitive advantage. G&A expenses were relatively stable at 3.5% of revenue in line with history. Overall, our non-GAAP net loss was 680 million RMB, representing a net loss ratio of 55%, a significant improvement from a year ago, which was 92%, albeit larger than the fourth quarter of 2018, mainly due to the seasonally weaker RPU.

Looking forward in terms of guidance based on our view of the market and operating conditions, which are subject to change, we expect revenues to be between 1.38 billion RMB to 1.42 billion RMB for the second quarter of 2019, representing a 23% to 27% quarter on quarter growth or 187% to 195% year on year growth.

RPU will improve, but it will take a little time before returning to the peak levels of last year, mainly as a result of the recent incremental supply in the digital advertising market, which has had downward pressure on pricing. We expect a net loss ratio of the second quarter of 2019 to be lower than for the first quarter of 2019 as a result of the improving RPU and our cost of discipline.

Our balance sheet has remained strong, with 1.6 billion RMB cash equivalents and the short-term investment. This doesn't include the $171 million proceeds received from the convertible loan issuance to Alibaba and the $31 million proceeds from issuing new shares in the follow-on share offering, both of which were received in early April.

Thank you very much and we'd like to open up to questions. Operator, please proceed.

Questions and Answers:

Operator

Ladies and gentlemen, we will now begin the question and answer session. If you wish to ask a question, please press *1 on your telephone and wait for your name to be announced. If you wish to cancel your quest, please press the # key. Once again, if you wish to ask a question, you may press *1 on your telephone and wait for your name to be announced.

Your first question comes from the line of Zhijing Liu of UBS. Please ask your question.

Zhijing Liu -- UBS -- Analyst

Hi, management. Thank you for taking my questions. I have two questions. Firstly, I see our second quarter revenue implies 4% to 7% increase over fourth quarter number. Does this weakness of revenue imply a guide down of four-year revenue target of 7.52 to 8.5 billion RMB? Second question is how do you see the challenge from emerging competitors with the same model as short video app, Taobao and free reading apps like [inaudible] -- how do you expect those apps can impact our user growth and margin profile? Thank you very much.

Jingbo Wang -- Co-Chief Financial Officer

Hi, Zhijing. Thank you for the question. This is Jingbo speaking. So, on your first question, first of all, I want to clarify that our guidance range for the second quarter of this year is 1.38 billion to 1.42 billion. That represents quarter on quarter growth rate of 23% to 27%. So, that's a pretty fast increase.

And on the full year revenue guidance, I like to say that so far in 2019 in terms of the advertising market, the demand side has been soft, given the overall macro environment. On the other hand, there has been a lot of incremental supply from the various companies and therefore putting a lot of pressure on pricing.

For the rest of 2019, I think there is still a lot of uncertainty in terms of the overall market condition. But we are pretty sure that our own operating efficiency was to improve on the platform side and also on the algorithm side. That will mitigate some of the pricing pressure. So, with that being said, I think overall for the full year of 2019, we currently think our revenue will fall in the range of RMB 6 billion to 7 billion. That's the first question.

On the second question on competition, we do notice that recently certain products, as you mentioned, have been competing with irrational models. For instance, a short video app was programmed similar to Qutoutiao is giving users significantly higher incentive while having almost no advertisement.

In other examples, we see free literature apps with also almost no advertisements. These models are economically unsustainable and they will have to change or disappear. In fact, we saw very similar products in early 2018 last year, which were growing very rapidly at first and eventually became pretty marginalized.

As we already explained in the prepared remarks, we have chosen not to participate in such irrational competition at this point, but rather to focus on optimizing our own products and user experience. Also, these products will cause some temporary slowdown in growth and put pressure on our margin in the short-term. As they pull back from such irrational behavior, which in our view is just a matter of time, we will be in stronger position to take market share.

Operator

Your next question comes from the line of Alicia Yap from Citi. Please ask your question.

Alicia Yap -- Citigroup -- Analyst

Thank you for taking my questions. I have two questions. The first is that you mentioned you'll be starting proprietary program for Midu novels. With that, how should we think about the content cost and revenue share incentive? My second question is can you elaborate more on Ali cooperation and when should we start to see some revenues or synergies from the partnership? Thank you.

Eric Tan -- Co-Founder and Executive Chairman

[Through Translator] So, Alicia, for your first question, we believe the proprietary writer platform is very important for the long-term value proposition and competitiveness of the Midu product. That's why in the initial stage, we intend to build a few successful cases of writers joining the program in order to attract more writers to join and therefore we will be giving a slightly higher revenue share to the initial writers.

However, as our team will continue to grow very rapidly, we believe in the mid to long-term the content cost from the proprietary platform will be similar to the current level, which is at about 20% of our revenue. That's for the Midu product and not for the overall company level because the revenue share is lower.

So, for your second question, the cooperation with Alibaba, I think there are mainly three aspects. Firstly, on the advertising side, Ali has been a single artist advertising for some time already. We are working very closely with Alipay to develop more native ways to drive traffic to these platforms. This will bring additional revenue to us. Most recently, Taobao is already increasing their spending platform. It is already 70% higher compared with previous months.

Secondly, on the loyalty point redemption side, we're testing allowing users to redeem their loyalty points for coupons or merchandise from Alibaba's platforms. This hopefully will further reduce our user engagement expenses. Currently, user engagement expenses account for more than 40% of revenue and we hope in cooperation with Alibaba, it will help us to significant reduce that expense.

Lastly, on the content side, Youku is now already our largest contributor of video content and Qutoutiao is one of the biggest distributors of Youku's videos. We're also discussing with the various other businesses with Alibaba on the content side.

Operator

Once again, if you wish to ask a question, please press *1 on your telephone and wait for your name to be announced. Your next question comes from the line of Hans Chung from KeyBanc Capital Management. Please ask your questions.

Hans Chung -- KeyBanc Capital Management -- Analyst

Good morning. Thank you for taking my questions. So, a couple questions -- one, regarding the user acquisition cost, what's the implication for the trend going forward? As we have mentioned, we may support the user growth because of the irrational competition. Should we think about the overall acquisition costs to be maybe lower than our previous forecast?

And then secondly, what's the trend for maintenance costs going forward? I think it's like if we take out the Midu, if you just look at the Qutoutiao, it looks like the maintenance costs per DAU per day remain flat quarter over quarter. What should we think about the trend, like how much we can continue to lower from the per user per day perspective going forward? Thank you.

Jingbo Wang -- Co-Chief Financial Officer

So, in terms of the user acquisition costs, I think you're right, we are being very cautious in terms of how much we spend and the volume of users we acquire. That will have some cost benefits. We expect in the second quarter, the user acquisition costs per user will be generally flat with the level you see in Q1. Longer-term, I think that still depends on growth strategy in case we accelerate this growth. We might see the UAC slightly increase.

In terms of the maintenance costs, first of all, in Q4, user maintenance cost per DAU per day for the Qutoutiao app alone was about RMB 0.23. And in Q1, it is between RMB 0.90 and RMB 0.20. There's still quite a significant increase, quarter on quarter. For Q2, we see some further decline on the Qutoutiao side and also, that will be further helped with Midu because we have no such expense. For the longer-term, we think the maintenance costs overall will continue to decline, but it's not going to be an indefinite decline. It will stabilize at a level around RMB 0.15 for this year.

Hans Chung -- KeyBanc Capital Management -- Analyst

So, the RMB 0.13 is overall or QDT only, the Qutoutiao app only for the full year?

Jingbo Wang -- Co-Chief Financial Officer

That's for the end of the year, not full year average. It's RMB 0.15 overall.

Hans Chung -- KeyBanc Capital Management -- Analyst

Okay. Got it. Thank you.

Operator

Your next question comes from the line of Xueru Zhang of 86Research. Please ask your question.

Xueru Zhang -- 86Research -- Analyst

Good morning, management. Thank you for taking my questions. I have some questions about your app sentiment. How do you see the current app sentiment trending from Q1 to Q2 and how should we think about the trend of our key advertising categories for the rest of this year and what can we do to improve the [inaudible] for Qutoutiao ad products? Thank you.

Jingbo Wang -- Co-Chief Financial Officer

So, normally, Q1 is a weak season for advertising. We see a pretty significant improvement from Q1 to Q2. However, this year, as we said in the prepared remarks, the overall advertising market in China has been weaker than expected. So, the recovery from Q1 to Q2 is not as significant as we previously expected. In terms of the key advertising categories, overall speaking, it has been similar to previous quarters. Comparatively, e-commerce has been stronger, but the overall market is still under a lot of pressure for all categories.

So, I think what we can do is really on the platform side. We cannot control the market pricing, but what we can do is improve our own bidding platform and also the targeting algorithm. In that regard, we think we are in a better position compared with many competitors, exactly because we are a younger platform. For a more mature platform, they have been operating for a very long time. All the optimization has been pushed to the limit. So, the facts they're pricing is really the market. For us, the optimization is far from perfect. Therefore, we think our optimization in the coming months will make a lot of the shortfall for the market pricing pressure.

Operator

Your next question comes from the line of Jay Dong of TH. Capital. Please ask your question.

Jay Dong -- TH. Capital -- Analyst

Good morning, management. Thanks for taking my question. My question is [inaudible] share more color about the MAU or DAU of Midu. At the same time, can management share more color about [inaudible]?

Eric Tan -- Co-Founder and Executive Chairman

[Through Translator] So, on Midu, I would like to refer you to the question about data, given this is around competition. So, according to Quest Mobile, the most recent data, it's 6.2 million DAU and close to 20 million MAU. The actual internal data is a bit higher than that, but that can be used as a good reference. We are seeing still pretty rapid growth on the MIDU side. For the short video app, as we said, we have been testing that app for a few months.

In Q1, its DAU is more than 1 million and in Q2, it's already significant higher, but we don't think the product is perfect at this point, so, we are continuing to optimize our product. We will push that product to the wider market and also, with more aggressive cost strategy in the coming months when the product itself becomes more fine-tuned.

Operator

Once again, if you wish to ask a question, please press *1 on your telephone and wait for your name to be announced. There are no further questions. I would like to turn the call back over to the company for closing remarks.

Fionna Chen -- Director of Investor Relations 

Thank you so much for joining today's call. If you have other questions or concerns or comments, please don't hesitate to reach out to the Qutoutiao IR team. This concludes the call. Have a good day.

Operator

This concludes the conference call. You may now disconnect your line thank you.

Duration: 38 minutes

Call participants:

Fionna Chen -- Director of Investor Relations 

Eric Tan -- Co-Founder and Executive Chairman

Jingbo Wang -- Co-Chief Financial Officer

Zhijing Liu -- UBS -- Analyst

Alicia Yap -- Citigroup -- Analyst

Hans Chung -- KeyBanc Capital Management -- Analyst

Xueru Zhang -- 86Research -- Analyst

Jay Dong -- TH. Capital -- Analyst

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