PDD Holdings Inc. Q3 FY2022 Earnings Call

Ladies and gentlemen, thank you for standing by. Welcome to PDD's Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. I must advise you that this conference is being recorded today. I would now like to hand the conference over to your host today, Mr. Chen Pang. Sir, please go ahead.

Thank you, operator. Hello, everyone, and thank you for joining us today. My name is Chen, and I will help host the earnings call. PDD's earnings release was distributed earlier and is available on our investor relations website, as well as through GlobeNewswire services. Before we begin, I would like to refer you to our Safe Harbor statement in the earnings press release, which applies to this call, as we will make certain forward-looking statements. Also, this call includes discussions of certain non-GAAP financial measures. So please refer to our earnings release, which contains a reconciliation of non-GAAP measures to GAAP measures. Joining us today on the call are Chen Lei, our Chairman and Chief Executive Officer; Liu Jun, our VP of Finance. Lei will make some general remarks on our performance for the past quarter and our strategic focus. Jun will then take us through our financial results for the third quarter ended September 30, 2022. During the Q&A session, Lei will answer questions in Chinese, and I will help translate. Please note that all translations provided are for reference purposes only. In case of any discrepancy between original remarks and the translated version, statements in the original remarks should prevail. Now, it is my pleasure to introduce our Chairman and Chief Executive Officer, Chen Lei. Lei, please go ahead.

Thank you, Chen, and hello everyone. Thank you all for joining our 3Q 2022 earnings call. Let me start by giving a brief overview of our third quarter results. Our total revenue for this quarter was RMB35.5 billion. This represents a year-on-year increase of 65%. Over the past quarter, we worked closely with our merchant partners to serve our customers. We continue to provide our users with an enjoyable and affordable shopping experience to meet their growing demand for high-quality and value-for-money products. During the past few months, many product categories, such as agriculture, consumer electronics, beauty, and cosmetics, have all enjoyed positive consumer feedback. Many brands joined Pinduoduo and extended their best deals to our consumers. We are happy to keep creating value for our consumers, but we still have areas to improve. The current industry competition remains intact. We need to continue to deepen our value creation, increase our R&D investment to further improve supply chain efficiency, support price upgrades, and facilitate agricultural digital inclusion. We celebrated our seventh anniversary last month, and we are extremely grateful for the support and trust from our consumers, merchants, farmers, and society. We will continue to uphold our core values of putting people first, benefiting more, and being more open, to create lasting value for all our stakeholders. Technology is at the heart of our value creation. From the very beginning, we committed to introducing technology to improve supply chain efficiency and create value for all parties through digitalization. In the past year, we increased our investment in technology and focused on driving innovation through research and development. We have built a young, energetic, and innovative team with a strong technology background, and we are encouraged to see that our investment in technology is having a positive impact on society. In agriculture, we continue promoting our holistic approach to digitalize the agricultural sector so that more and more people can benefit from advances in science and technology. Our approach to agriculture is a holistic way of creating inclusive growth by leveraging the resources of Pinduoduo. We hope that more farmers will adopt agricultural technology to improve their productivity and cultivate their farming practices more sustainably. Last quarter's harvest festival is a good example of this approach. In September, Pinduoduo launched a dedicated initiative for the platform to support the annual harvest festival through its exclusive e-commerce platform. Last month, the harvest festival featured over 0.5 million types of agricultural products across the country. We brought the market to farmers by bringing them into the digital economy. Millions of consumers also make it more feasible to implement agricultural technology. Farmers are more willing to improve their crops if they have confidence that consumers will buy them. During the harvest festival, we worked with CCTV and assembled professors from the Chinese Academy of Agricultural Sciences and the China Agricultural University to promote agricultural technology. For example, we introduced a new variety of sweet potatoes that are less prone to disease, developed by research institutes. The Pinduoduo platform helped this new sweet potato reach more consumers naturally. This crop is not grown in many parts of China and is available year-round. Its success has helped many farmers to prosper. This is a good example of how market demand can bring more research outputs from the lab to the field. We are committed to using the Pinduoduo platform to help consumers discover new agricultural products so that they can enjoy healthier and more nutritious food. During the harvest festival, we also showcased a series of new and improved wheat varieties cultivated by China Agriculture University with the support of our 10 billion agricultural initiative. These wheat varieties have higher yields, higher quality, and are more resistant to disease. In addition, we continue to support various events to promote the adoption of agricultural technology. Our flagship smart agriculture competition is currently underway in Shanghai, and this is an annual precision farming contest aimed at agricultural researchers to develop practical technology. We are partnering with China Agricultural University and Zhejiang University for this competition, with the technical support from FAO China and the Zhejiang Academy of Agricultural Sciences. The theme of this year's competition is vertical farming. Participating teams will compete to produce lettuce in shipping containers, using lightning, cross-modeling, and algorithms to consume input variables. Several teams from the first two editions have already implemented their technology on functioning farms, as well as in large-scale pilot solutions. We hope this initiative can inspire more young researchers, bring more research findings to the market, and support the development of agriculture. Similarly, we are improving agricultural digitization. We are helping to upgrade real economy enterprises and manufacturers by connecting them directly with end consumers. Our pioneering team purchase model can quickly and directly connect devices through gathering consumer demand. We have leveraged digital e-commerce technology to shorten the product development cycle and help manufacturers create products that closely match market needs. This can help manufacturers build their brands. In the past several years, we have helped incubate nearly 1,000 manufacturing brands through technology. Since the beginning of this year, we have launched several activities to support the manufacturing industry. For example, this year, we launched a new craftsman campaign to help local craftsmen and manufacturers gain a bigger market for their products through e-commerce. We have allocated dedicated resources to support high-quality local products and help small enterprises upgrade their branding. The new craftsman program is now in many regions across the country, helping local manufacturers build their brands. We hope to use the Pinduoduo platform to help more undiscovered manufacturers reach potential buyers. Increasing their market exposure will also benefit local communities, leading to more income and job opportunities. As we enter our eighth year of operation, we remain passionate and excited about the future. We are a young company with a dynamic and driven team, and we will continuously grow our areas of positive value creation through technology. And with that, Jun will take us through the financials.

Thank you, Lei. Hello, everyone. I will go through our performance in the quarter ended September 30, 2022. In terms of P&L, our total revenues in the quarter were RMB35.5 billion, up 65.1% from RMB21.5 billion in the same quarter of 2021. This was primarily driven by an increase in revenues from online marketing services and transaction services. Revenues from online marketing services rose to RMB28.4 billion this quarter, up 58.4% compared with the same period of 2021. This growth was mainly due to increased merchant activities in Q3. Our transaction services revenue this quarter was RMB7 billion, reflecting an increase of 102% versus the same period of 2021. Moving on to costs and expenses, our total cost of revenue increased by 13% from RMB6.6 billion in Q3 2021 to RMB7.4 billion this quarter. Total operating expenses this quarter were RMB17.6 billion, compared to RMB12.8 billion in the third quarter of 2021. Our investment in certain projects, including a few agriculture-related initiatives, factored into Q3. As a result, our total operating expenses as a percentage of total revenues have declined from 59.6% in Q3 2021 to 49.7% in this quarter. Looking into specific expense items, our non-GAAP sales and marketing expenses this quarter were RMB13.4 billion, accounting for 39% versus the same quarter of 2021. On a non-GAAP basis, our sales and marketing expenses as a percentage of our revenue this quarter were 37.9%, compared with 44.9% for the same quarter in 2021. Our non-GAAP general and administrative expenses were RMB226.3 million versus RMB178.1 million in the same quarter of 2021. Our non-GAAP research and development expenses were RMB2.1 billion, representing a 15% increase from RMB1.9 billion in the same quarter of 2021. The increase was primarily due to an increase in headcount and the hiring of more experienced R&D personnel. We're committed to growing our R&D capabilities, and we will step up our spending to drive innovation on our platform to meet evolving customer needs and lay a foundation for sustainable growth. In agriculture, we continue to deepen our investment in agritech and promote its adoption. Technology is key to increasing supply chain efficiency and helping facilitate the development of the manufacturing industry. Operating profits for the quarter stood at RMB10.4 billion on a GAAP basis compared to RMB2.1 billion in the same quarter of 2021. Non-GAAP operating profit was RMB12.3 billion versus RMB3.3 billion in the same quarter of 2021. Net income attributable to ordinary shareholders was RMB10.6 billion compared to RMB1.6 billion in the second quarter of 2021. Basic earnings per ADS were RMB8.38, and diluted earnings per ADS were RMB7.34 compared to basic earnings per ADS of RMB1.31 and diluted earnings per ADS of RMB1.15 in the third quarter of 2021. Non-GAAP net income attributable to ordinary shareholders was RMB12.4 billion, compared with RMB3.1 billion in the same quarter last year. Non-GAAP diluted earnings per ADS stood at RMB8.62 versus RMB2.18 in the second quarter of 2021. In summary, we think the current level of profitability in Q3 is temporary and likely not sustainable. On one hand, reinvestment in certain projects impacted the last quarter. On the other hand, we continue to see user engagement contributing to revenue growth. This shows that our financial and business cycles are not always in sync. We plan to increase our investment to further drive innovation on our platform and strengthen our core capabilities. Thus, we believe that maintaining the profit levels of the past quarter is unlikely. That completes the profit and loss statement for the third quarter of 2022. Now, let me move on to cash flow. Our net cash flow generated from operating activities was RMB11.7 billion compared with RMB8.7 billion in the second quarter of 2021, primarily due to increased net income and changes in working capital. As of September 30, 2022, the Company had RMB137.8 billion in cash, cash equivalents, and short-term investments. Thank you. This concludes my prepared remarks.

Thank you, Jun. Next, we will move on to the Q&A session. For today's Q&A session, Lei and Jun will take questions from analysts on the line. We can take a maximum of two questions per analyst. Lei will answer questions in Chinese, and I will help to translate Lei's remarks for ease of reference. Operator, we may now take questions on the line.

Thank you very much. Ladies and gentlemen, we will now begin the question-and-answer session. The first question comes from the line of Joyce Ju from Bank of America. Please go ahead.

Thanks management for taking my question. I have two questions. My first question is: Your online marketing services revenue this quarter delivered a faster growth rate than last quarter. What's the reason for this reaccelerated growth in the third quarter? How should we understand the growth rate momentum in the future? And the second question is: Could management share the latest update on your international initiatives? Could you share your views or any takeaways at this stage? Does the current level of development meet the management's original expectations?

Joyce, let me take your two questions. Regarding your first question on growth, during the third quarter, we collaborated closely with our merchants to create value for our consumers. We worked to bring our consumers more savings and better shopping experiences on the Pinduoduo platform, utilizing various methods, including coupons and promotional events. Simultaneously, we observed a growing demand from our consumers for high-quality products. We actively made efforts to satisfy their demand, and this year, more and more brands have started to cooperate with us. They provide more choices for consumers in categories such as agricultural produce, electronics, home appliances, and cosmetics. These categories have received positive customer feedback, and we are grateful for the trust our consumers place in us. However, we recognize that industry competition remains intense, and consumer preferences and demands are becoming increasingly diversified. Thus, we still have many areas to improve. The impact of our overall investment activity, in fact, is not beneficial to our long-term competitiveness. In the future, we will continue to step up investments to better understand our consumers’ needs and serve them more effectively. Additionally, we will need to immerse ourselves deeply in the real economy and invest in technology R&D to help improve efficiency in agriculture and the manufacturing sector. These efforts will support high-quality development over the long run. As for your second question regarding our international business, in our last quarter's earnings conference call, we shared that we are working on our international business. Many of you may have noticed that we rolled out our international marketplace in September, which has just been a few months since we started this business. For our team, international business is a new area where we will start with the fundamental needs of consumers, applying the operations and supply chain know-how and experiences that we have gained over the years while striving to create unique value. We fully respect the differences across various markets and understand the necessity to experiment continually, expecting the process to be filled with challenges. We will be patient and work together with our partners to create long-term value for consumers. Currently, we are still in the early stages of exploration and have many areas needing improvement in terms of the services that we provide. We need to learn and optimize. The process itself will take time. However, I am confident that the experience we gain along the way will be very valuable for our company and our team. Thank you. Operator, we are ready to move on to the next question.

Thank you. The next question is from the line of Thomas Chong from Jefferies. Please go ahead.

Thanks, management for taking my questions. My first question is related to the main drivers behind this quarter's revenue growth. If we further break down the revenue to GMV and take rates, can you share more about the trends in these two factors? Also, have you changed the take rate policy for merchants on your platform? And then I have another quick follow-up. My second question is also related to the first one. Apart from take rate policies, I'm also wondering for merchants and the industry upstream: Can you also help to share if you have support measures and policies? Could management share more about your progress again in this area? Thank you.

Hi, Thomas. So let me address your second question about our support for the manufacturing sector and the supply chain first. From the beginning, we have leveraged our technical background to help improve efficiency in the manufacturing sector. Our team purchase model aggregates orders and connects demand and supply sides directly, helping manufacturers reduce intermediary layers and reach consumers directly. In the process, this aids brands in creating their own brands and manufacturing capabilities. Over the past seven years, Pinduoduo has helped build nearly 1,000 brands through technology while growing alongside many manufacturers. Additionally, we provide a one-stop digital solution covering the entire value chain to our manufacturing partners in order to support traditional manufacturers and factories in their digital transformation. We collaborate with these manufacturers on product designs and adjustments, significantly reducing costs and uncertainty during the R&D and production processes. All of these initiatives generate value for consumers by providing quality products at savings. This, in turn, creates a virtuous cycle among consumers, our manufacturing partners, and the Pinduoduo platform. This year, we have introduced several dedicated initiatives to support manufacturers with technology across various industries, such as consumer appliances, apparel, sports, cosmetics, homecare, and furniture. We will continue to invest in these areas to enhance supply chain efficiency. Thank you.

Thanks, Thomas. I will take your first question about GMV. In the third quarter, we worked closely with our merchants to serve our consumers and improve their shopping experience. As consumer activities and engagement grow, we find that merchants are looking to our platform for growth and opportunities. Financial metrics such as GMV and revenue mainly reflect the value we create. Thus, for us, the most important goal is consistently increasing value creation. We will continue to invest in deeper consumer engagement and technology capabilities, which will lay the foundation for our long-term development. Thank you.

Operator, we can move to the next analyst in line.

Thank you. The next questions come from Ellie Jiang from Macquarie. Please go ahead.

Let me translate my question. First, could management talk about the latest industry trends, including what we saw in the fourth quarter? Have we talked about our performance during the 11.11 promotion? What key industry themes have we seen in this regard? Secondly, could management share with us the financial impact of this initiative? What are the main financial statement line items it impacts? Could you help us quantify the impact for the third quarter? And what level of investment do you expect to make going forward?

Hi, Ellie. Let me take your question on industry trends. We always start from consumers' fundamental needs, aiming to create value for them every single day throughout the year. This is the core driver for the industry and for ourselves. We also understand that improving consumer experience and deepening their trust requires patience and is a gradual process. Shopping festivals and promotions are just a part of the many ways to effectively serve our consumers. We hope to provide consumers with more savings and enjoyment while shopping on Pinduoduo. When planning shopping festivals and events, we remain consumer-centric and employ simple rules for an enjoyable shopping experience. This year, we collaborated with many brands and merchants to bring more quality products to consumers, satisfying their diverse needs across different categories and consumption scenarios. As for the industry, we observe that competition remains intense, necessitating patient investment in the supply chain. We need to step up investment in technology and innovation to enhance overall supply chain efficiency and support developments in the agriculture and manufacturing sectors, thereby enabling us to better meet consumers' increasing demand for quality products. Thank you.

Thanks, Ellie. I will take your question regarding the financial statements related to our international initiatives. First, our international business is currently in a very early stage. It is undergoing constant trials as we focus on how to create unique value. We believe that financial metrics are naturally results of the value we create. Since the international business is still at an early stage, the impact on our financial numbers is small. Like other parts of the business, we carefully assess the ROI of our investments. Thank you.

Operator, we can move on to the next question.

Thank you. The next question comes from Kenneth Fong from Credit Suisse. Please go ahead.

Thank you, management, for taking my question. Could management share the latest thoughts and developments in agriculture? Are there any cases or projects into which you're putting resources? What is the latest financial impact on your financial statements? Additionally, regarding your 10 billion agricultural initiative, is there any update you can share? For my second question, we have delivered profitability for six consecutive quarters. We have also noticed that many of your peers have started to focus more on cost control and efficiency improvement. Does your profitability for the past three quarters indicate that you have begun to pursue a similar strategy? Should we expect a similar level of profitability to continue over the next quarter? Thank you.

Kenneth, let me address your question on agriculture first. We have previously shared that agriculture is a long-term strategy for us. We aim to promote agricultural development through technology. Though many efforts are still in early stages, we already see various areas to create value. We appreciate the opportunity to share our latest developments in this area. We see our technological background aiding in enhancing the distribution efficiency of agricultural products. During the third quarter, our dedicated promotional events, such as the harvest festival and agricultural festival, helped cover thousands of production regions and broaden market access for farmers. This also enables our consumers to enjoy quality agricultural produce in a shorter time. The increased sales volume further commercializes agritech solutions and enhances research efforts. For instance, during our harvest festival event, we introduced many agricultural products developed with agritech resources, which allow products to swiftly enter the market and turn agritech breakthroughs into consumer goods. Regarding our 10 billion agricultural initiative, we recently introduced a few new wheat varieties developed by China Agriculture University with the support of this initiative. We remain committed to down-to-earth, long-term patient investments while bringing more agritech results to market. Moving forward, we will continue sharing updates with you.

Thanks, Kenneth. I will take your second question regarding our profitability. I would like to emphasize that the high level of profitability for Q3 is unlikely to continue. Over the past quarter, some of our projects, including a few agriculture-related ones, were impacted in terms of timelines and investment pace. Consequently, our quarterly expenses were affected, while our revenue increased due to heightened merchant activities. This indicates that our business cycles and financial reporting cycles are not always in sync. As such, we believe this level of profitability may not be sustainable. Moreover, we are still in the development phase, and profitability is not our current priority. We will continue to amplify investments, especially to support agriculture and the manufacturing industry through technology. This may cause fluctuations in our future profitability, and the Q3 level is unlikely to persist. Thank you.

Okay. Operator, it's about time. Thank you, everybody, for joining us today on the conference call. If you have any further questions, please feel free to reach out to the IR team. Thank you all, and have a great day.

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may all disconnect.