PDD Holdings Inc. Q2 FY2024 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to PDD Holdings Inc. Second Quarter 2024 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. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your host today. Sir, please go ahead.

Thank you, operator. Hello, everyone, and thank you for joining us today. PDD Holdings earnings release was distributed earlier and is available on our website at investor.pddholdings.com, as well as through the 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. Please refer to our earnings release which contains a reconciliation of non-GAAP measures to GAAP measures. Joining us today on the call are Mr. Chen Lei, our Chairman and Co-Chief Executive Officer; Mr. Zhao Jiazhen, our Executive Director and Co-Chief Executive Officer, as well as Ms. Liu Jun, our VP of Finance. Lei and Jiazhen will make some general remarks on our performance for the past quarter and our strategic focus. Jun will then walk us through our financial results for the second quarter ended June 30, 2024. During the Q&A session, Lei and Jiazhen will answer questions in Chinese and help translate. Please kindly note that the English translation is for reference only, and in case of any discrepancy, statements in the original language should prevail. Now it's my pleasure to introduce our Chairman and Co-Chief Executive Officer, Mr. Chen Lei. Lei, please go ahead.

Thank you. Hello, everyone. Thank you all for joining our earnings call for the second quarter of 2024. For the first half of 2024, we have remained committed to our high-quality development strategy and consistently invested in our platform ecosystem. We received positive feedback for these efforts. Consumer experience and our services have continued to improve. A number of new merchants and products have grown significantly. This further meets the diverse needs of our consumers. This quarter, we benefited from the improving macro environment and achieved robust financial results. Our total revenues reached RMB97 billion, which represents a year-on-year increase of 86%. However, we are seeing many new challenges ahead, from changing consumer demand, intensifying competition, and uncertainties in the global environment. As a result, we will enter a new phase of high-quality development that calls for increased investments. Our profitability will be affected as a result. Since the beginning of this year, we are seeing that consumer preferences have become more diverse. On one hand, consumers are increasingly choosing experience-based consumption over material purchases. On the other hand, there is a growing emphasis on rational consumption. Consumers are making more thoughtful decisions to balance quality and value. In response, we have collaborated with high-quality brands and manufacturers to create customized products that cater to these diverse demands. This approach has not only propelled many new brands to success but also revived the popularity of many established brands. This is just one example of how digital technology and manufacturing can come together to create new opportunities. At this moment, the competition among e-commerce platforms is quickly escalating, and therefore, it's even more important that we go back to the basics of supply chain improvements and invest firmly in supply chain efficiencies. This will be the key focus for our high-quality development going forward. For example, in the second quarter, our teams continued to bring our agriculture cloud initiative to major production regions, helping local growers to bring seasonal foods directly to people's homes. In this process, we promoted local agriculture brands. In addition, to further improve the agriculture supply chain, nurture research talents, and promote technology inclusion, we continue to support the smart agricultural competition and Duo Duo Academic growing competition. The Agricultural Research Fund we established in cooperation with China Agriculture University has also started to bear fruit. On the manufacturing side, we are pleased to find that many small and medium-sized businesses have been using our digital capabilities from our platform to support product iteration and innovation. Through this process, they have not only emerged stronger from the competition but also led the local industries towards high-quality development. These results have strengthened our commitment to further investing in high-quality development. We have communicated on a number of occasions that profit growth in the past few quarters should not be used as long-term guidance, and it is a result of the mismatch between the business investment and the financial reporting cycles. As we enter a new phase of investment, I would like to make it clear to our investors that our profits will gradually trend down starting in Q3, and there will be fluctuations or rebounds in the short term. In the long run, the decline in profitability is inevitable. Finally, our platform has reached a considerable scale and we will remain committed to high-quality development and focus on creating a healthy and sustainable platform ecosystem. To this end, we adopt the necessary policies to vigorously support high-quality merchants and tackle low-quality ones. On the supply side, we will invest substantial resources to support high-quality merchants who are willing to innovate and improve quality. We will also offer significant transaction fee reductions to these merchants, with an initial target of 10 billion in the first year. By doing so, our goal is to provide clear incentives for the merchants to join high-quality development. On the other hand, we will further deepen our trust and safety capabilities to improve our merchant ecosystem and strengthen our supply chain. We are actively identifying and removing unlawful vectors from our platforms, and we will continue to strengthen these efforts. At the moment, we have already started a new round of investments in operations and R&D to streamline the merchant onboarding and product listing process. Leveraging technology, we will gradually improve the quality of our products sold on our platforms and create a fair and transparent business environment for our merchants. In this process, we believe that sacrificing short-term profit is necessary. A clear downward trend in profit is expected, but we are prepared to invest firmly and thoughtfully in the platform's long-term health. This decision has received unanimous support from our entire management team. And now moving onto the global business. In the past few quarters, we have noticed the rapid shifts in the external environment, which brought significantly greater uncertainty. Our operations have also become increasingly affected by non-business factors. Meanwhile, the competition we face is growing stronger. Competition is here to stay and is expected to intensify in our industry. Our global business is facing significant uncertainties from intense competition and an evolving external environment. These factors combined will inevitably cause fluctuations to our business. As shown in this quarter's results, high revenue growth is not sustainable and a downward trend in profitability is inevitable. As the environment evolves and our company continues to grow, our management team and I frequently discuss how we can better fulfill our corporate social responsibilities. We believe there are still many things that can be done, for example, through enhancing our governance structure and extracting resources to better adapt to changing times. We can also do more to give back to society to support agriculture and other industry sectors and offer greater support to those who need it the most. We fully recognize that measuring our company's performance by short-term capital returns no longer aligns with where we are today. As a global company in this sector, we are committed to driving innovation, adapting to change, and taking on greater social responsibilities globally. Now, I will hand it over to our Co-CEO, Zhao Jiazhen to talk more about our operations in the second quarter.

Thank you, Lei. Hello, everyone. This is Zhao Jiazhen. Thank you all for joining our earnings call for the second quarter of 2024. In the first half of this year, online retail in China continued to perform well, bringing fresh energy to the overall consumption market. Over the past quarter, we continued to advance our high-quality development strategy, making steady long-term investments to support both supply and demand sides of our platforms. Looking ahead to the second quarter of this year and beyond, we're very confident in the future of the Chinese consumer market. This quarter, we continued to focus on consumer demand, further enhanced our savings and service capabilities, and upgraded our after-sales services to provide consumers with more value and a more enjoyable shopping experience. During the dual agents promotion, we continued to provide consumers with straightforward savings and introduced new promotions to meet the increasingly diverse consumer preferences. We also brought product categories like fresh produce, daily necessities, and high-end appliances into third and fourth tier cities, contributing to consumption upgrades across the regions. On the supply side, we stepped up our support for quality merchants and brands, directing more traffic to high-quality products through the 10 Billion Program and fresh sales. We have also focused on enhancing the quality and efficiency of the supply chain, bringing more value to the agricultural areas and industry regions, benefiting more producers, quality agricultural, and domestic groups. To support the countryside home appliance program and the consumer group trade-in, we invested RMB1 billion during the first week of June 18. This boost led to remarkable growth for many local brands in categories such as electronics, home appliances, kitchenware, and household products. For example, utilizing our digital technology, we helped a local brand with 36 years of history understand the latest market demand and return to growth with a blockbuster product, achieving RMB100 million in sales after joining the platform for just two months. Additionally, the number of new merchants and products on our platform saw meaningful growth. In the first week of June 18, the number of merchants participating in the 10 Billion Program grew by over 90% year-on-year, and the number of agricultural merchants increased by 83% year-on-year. Our platform also attracted many new merchants in categories such as electronics, home appliances, and cosmetics. To create a better business environment for high-quality merchants, we have introduced a new round of investments in operations and R&D. Our goal is to build industry-leading compliance capabilities and foster a healthy platform ecosystem. We continue to streamline our merchant onboarding and product listing processes to better control product quality and offer consumers a safe and reliable shopping experience. We integrate automated technology for product screening with thorough manual reviews by our trust and safety team. This approach ensures rigorous oversight on product compliance while avoiding unintended penalties for quality products and merchants. At the same time, we have invested heavily in developing comprehensive, user-friendly training materials for merchants to boost their compliance capabilities. This effort aims to enhance supply chain quality while helping merchants lower compliance costs and expand their market reach. We recognize that building a healthy platform ecosystem and achieving high-quality development is a gradual process, especially given the consumer scale of our platforms. Therefore, we are committed to a dual approach. One side involves supporting high-quality merchants while addressing issues with low-quality ones to create a healthy and sustainable ecosystem. In this process, we will inevitably incur short-term costs. As Lei has mentioned, our management team is fully committed to long-term investments for the health of our platforms. While profits may vary or even rebound in the next few quarters, it’s unavoidable that profitability will decline over the long term. As the largest platform for agricultural products in China, we further advanced our agricultural strategy this quarter. We launched the Science and Technology Courtyard project in Yunnan Valley and Shanxi, Huiping, and kicked off the fourth smart agricultural competition in collaboration with top research teams from around the world. We will continue to increase investments in agricultural research to promote the commercial application of research funding and accelerate the market adoption of high-quality agricultural products. Meanwhile, we leverage our platform strength, working with ecosystem partners to take on more social responsibilities. We invested tens of millions in Reading Month and subsidies to launch a seventh total Reading Month, providing direct discounts on thousands of book products to make knowledge more accessible. 2024 is a critical year for our high-quality development. We will focus on creating a healthy and sustainable platform ecosystem and empowering our ecosystem partners with more platform resources and technical support, laying a solid foundation for our platform's high-quality development. Next, I will hand it over to Jun, who will provide an update on our financial performance for the second quarter.

Thank you, Jiazhen. Hello, everyone. Let me walk you through our financial performance for the second quarter ended June 30, 2024. In terms of income statements in the second quarter, our total revenues increased 86% year-over-year to RMB97.1 billion. This was mainly driven by an increase in revenues from online marketing services and transaction services. Revenues from our marketing services and others were RMB49.1 billion this quarter, up 29% from the same quarter of 2023. Revenues from transaction services were RMB47.9 billion, up 234% from the same quarter last year. In Q2, our top-line growth slowed down significantly versus the last few quarters. Further slowdown is inevitable as a result of competition and global uncertainties. Moving onto costs and expenses. Total cost of revenues increased 80% from RMB18.7 billion in Q2 2023 to RMB33.7 billion this quarter, mainly due to an increase in fulfillment fees and payment processing fees. On a GAAP basis, total operating expenses this quarter increased 48% to RMB30.8 billion from RMB20.9 billion in the same quarter of 2023. On a non-GAAP basis, total operating expenses increased to RMB28.4 billion this quarter from RMB19 billion in Q2 2023. In Q2, we continued to invest firmly to support the high-quality development of our platforms. Core total non-GAAP operating expenses as a percentage of total revenue this quarter was 29% compared to 36% in the second quarter last year. Looking to specific expense items, our non-GAAP sales and marketing expenses this quarter were RMB25.4 billion, up 54% versus the same quarter last year. Throughout Q2, we stepped up our promotional efforts to give back to consumers, and investing marketing to promote our platforms. On a non-GAAP basis, our sales and marketing expenses as a percentage of our revenues this quarter was 26% versus 32% for the same quarter last year. Our non-GAAP general and administrative expenses were RMB594 million versus RMB370 million in the same quarter of 2023. Our research and development expenses were RMB2.4 billion this quarter on a non-GAAP basis, up 15% year-over-year and RMB2.9 billion on a GAAP basis. It's critical that we maintain our long-term focus and continue to invest in R&D to drive supply chain efficiency and customer experience. On a GAAP basis, operating profit for the quarter was RMB32.6 billion versus RMB12.7 billion in the same quarter last year. Non-GAAP operating profit was RMB35 billion versus RMB14.6 billion in the same quarter last year. Non-GAAP operating profit margin was 36% this quarter compared with 28% for the same quarter last year. Net income attributable to ordinary shareholders was RMB32 billion for the quarter compared to RMB13.1 billion in the same quarter last year. Diluted earnings per ADS was RMB23.14, and diluted earnings per ADS was RMB21.61 versus base earnings per ADS of RMB9.64 and diluted earnings per ADS of RMB9 in the same quarter of 2023. Non-GAAP net income attributable to ordinary shareholders was RMB34.4 billion versus RMB15.3 billion in the same quarter last year. Non-GAAP diluted earnings per ADS was RMB23.24 versus RMB10.47 in the same quarter of 2023. As noted last quarter, our business does not follow a linear path, and the profitability in the last few quarters does not represent future trends. Looking ahead, we will invest firmly to support a healthy ecosystem that encourages high-quality merchants. Our profitability may fluctuate in the short term, but we are on a gradual track toward lower long-term profitability. This is inevitable as we focus on the long-term, high-quality development of our platforms. That completes the income statements. Now let me move on to cash flow. Our net cash generated from operating activities was RMB43.8 billion compared with RMB23.4 billion in the same quarter last year. As of June 30, 2024, we have RMB284.9 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. In today's Q&A session, Lei, Jiazhen, and Jun will take questions from analysts on the line. We will take a maximum of two questions from each analyst. Lei and Jiazhen will answer questions in Chinese and we will help translate for convenience purposes. Operator, we are open for questions.

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

I have two questions. First, total profit growth has remained strong this quarter. However, management mentioned potential increased investment and profitability fluctuations due to competition. Can you share your assessment of the profit plan moving forward? Additionally, regarding shareholder returns, do you have any plans for share buybacks or dividend payouts? My second question is about the merchant ecosystem and the policies supporting merchants that management highlighted. Could you elaborate on your understanding of the merchant ecosystem, how you assess it, and why it will be a focus for the platform in the next stage? Thank you.

All right. This is Chen Lei. Let me address your first question. We have stated multiple times that the profit growth observed in recent quarters should not be taken as a long-term indicator. This growth has stemmed from a mismatch between our business investments and the financial reporting cycle. Additionally, we are currently experiencing significant competition and changing external factors, which will likely lead to fluctuations in our performance and a slowdown in our revenue growth. We are now transitioning into a phase focused on stable, high-quality development, which requires us to invest patiently in the long-term health of our platform. To ensure sustainable growth for our ecosystem, we will allocate considerable resources over the next year to support high-quality merchants. While our profitability might experience short-term fluctuations, we expect it to trend downward in the long run. Supporting merchants is vital for strengthening our high-quality supply chain and building a resilient platform ecosystem, which will ultimately create a positive cycle for the platform. Therefore, we are committed to making patient investments, even though this may impact short-term profits. Regarding shareholder returns, the company is still in the investment phase, facing significant competition and external uncertainties. As such, our management team and I collectively agree that now is not an appropriate time for share repurchases or dividend distributions, and we don’t foresee a need for this in the coming years. Thank you.

Hi, this is Zhao Jiazhen. Let me address your question about the merchant ecosystem. Our platform consists of a connected community of merchants, consumers, and our operations teams. Merchants are crucial partners in our efforts to serve consumers. With increasing competition in our industry, new demands arise within our community. We feel a strong responsibility as a platform; we need to ensure strict oversight of product quality to prevent substandard goods and protect consumer rights. At the same time, we must promote fairness so that dedicated, high-quality merchants can receive meaningful rewards, which is vital for the healthy development of our ecosystem. To maintain this balance, we are committed to transitioning towards high-quality development. We will implement policies to support high-quality merchants while addressing those of lower quality. On the supply side, we will strongly assist merchants with product and technology innovation capabilities and significantly reduce transaction fees for these high-quality merchants, with an anticipated reduction of RMB10 billion in the coming years. We will further enhance incentives to drive the high-quality development of the ecosystem. Additionally, we will strengthen our platform governance to enforce compliance among merchants, which includes removing unlawful merchants to reinforce our supply chain. We have initiated a new investment round in operations and technology to improve the merchant onboarding and product listing processes, ensure strict product quality control through advanced technology, and create a better environment for high-quality merchants. We grow alongside our valued merchant partners, collaboratively offering consumers high-quality products and services that foster new growth opportunities for the ecosystem, creating a virtuous cycle essential for the long-term health of our community. Our management is united in committing to long-term investments to achieve a vibrant, sustainable platform ecosystem. Thank you all.

Operator, let’s move on to the next analyst on the line.

Thank you. The next question is from Yang Bai from CICC. Please go ahead.

Thank you, management. I have two questions. First, it seems that your global business growth is still strong, but some external data indicates a slowdown in growth rates and investment in specific markets. In your prepared remarks, you mentioned a cautious approach to future global business development. Is the company aiming to proactively manage some risks? Could you please elaborate on your thoughts regarding this? Secondly, the competitive environment appears to be quite intense. Has this affected the company's growth? In such a competitive landscape, how will you adjust your investment priorities, and what is your perspective on positioning? Thank you.

Hi. This is Lei. Let me address your question regarding our global business. Our global business is still developing, and we are actively seeking new opportunities. We are currently operating in over 70 markets. Throughout this call, we have emphasized the importance of compliance as a foundation for our growth. Over the last few quarters, we have dedicated significant resources to create a safe shopping environment. As our business progresses, we've observed that external changes are speeding up. Our operations are becoming increasingly influenced by non-business factors, leading to a rise in uncertainty. Additionally, competition within the e-commerce sector remains a constant and is expected to become more fierce. This heightened competition, along with external pressures, will inevitably disrupt our global business. Nevertheless, we are dedicated to our goal of enabling more consumers around the world to benefit from the digital economy, and this commitment remains unchanged. In response to this complex environment, we will concentrate on our core strengths and continually enhance our capabilities in areas like supply chain, customer service, and compliance to better meet global consumer expectations and achieve high-quality growth in our global business. Thank you.

Hi, this is Zhao Jiazhen. Let me address your question regarding competition. In recent quarters, we have seen an increase in competition, which is to be expected in the e-commerce industry. As a result, our revenue growth mix has experienced a decline. For example, in the second quarter, our revenue growth decreased, suggesting that achieving high revenue growth may not be sustainable. Presently, consumer demand is becoming more varied, prompting e-commerce platforms to adjust their strategies accordingly. Each platform possesses unique strengths and competitive advantages and invests significant resources to respond to consumer needs. At this time, we need to concentrate on our core strengths and continue to pursue high-quality development. A solid supply chain is crucial for e-commerce platforms to provide excellent services to consumers. To address the diverse needs of consumers, we remain focused on the fundamentals and aim for innovation in the supply chain. In the second quarter, our teams worked on agricultural initiatives in key production areas, aiding local agricultural products in reaching their branding potential and supporting small and medium-sized agricultural merchants through collective marketing efforts. Beyond agricultural products, we have broadened our assistance to manufacturers through digitalization. By partnering with high-quality national brands and manufacturers, we have successfully introduced customized products for niche markets. This initiative has allowed our brand and merchants to achieve higher quality development through ongoing technological enhancements and product innovation. We are committed to encouraging and supporting high-quality merchants who are focused on their business and innovation. In addition to significantly lowering transaction fees, we will continue to utilize our platform’s supply chain capabilities to help merchants enhance quality and efficiency and direct manufacturers toward innovative and high-quality development. We recognize that optimizing and upgrading the supply chain is vital to satisfying deeper consumer needs and ensuring the long-term healthy growth of our platform ecosystem. We are dedicated to making long-term and patient investments. Thank you all.

Thank you, Jiazhen, and thank you all for joining us today. We look forward to speaking with you again next quarter, and thank you. Have a nice day.

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