Earnings Call Transcript - PDD Q3 2021

Operator, Operator

Good day, ladies and gentlemen. Thank you for standing by, and welcome to the Pinduoduo Third Quarter 2021 Earnings Conference Call. Please be advised that today's conference is being recorded. I will now turn the call over to your host for today's call, Mr. Chung Khoan. Please go ahead, sir.

Chung Khoan, Unidentified Company Representative

Thank you, operator. Hello, everyone, and thank you for joining us today. My name is Chen, and I will help host the earnings call today. Pinduoduo earnings release was distributed earlier and is available on our website at investor.pinduoduo.com as well as through GlobeNewswire services. Before we begin, I would like to refer you to our Safe Harbor statements in 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 the non-GAAP measures to GAAP measures. Joining us today on the call are Chen Lei, our Chairman and Chief Executive Officer; Tony Ma, our VP of Finance. Lei will make some general remarks on our performance for the past quarter and our strategic focus going forward. Tony will then elaborate further on specific strategic initiatives and take us through our financial results for the third quarter ended September 30, 2021. After that, we will open the floor to questions from analysts. During the Q&A session, Lei will answer your questions in Chinese and Preston will help translate. Please kindly note that all translations provided are for ease of reference only. In case of any discrepancy between our original remarks and translated version, statements in the original language should prevail. Now it is my pleasure to introduce our Chairman and Chief Executive Officer, Chen Lei. Lei, please go ahead.

Chen Lei, CEO

Thank you, Chung. Hello, everyone, and thank you for joining our results announcement for the third quarter of 2021. Our total revenue for this quarter, excluding revenue from merchandise sales, was RMB 21.4 billion. This represents a year-on-year increase of 55%. Our annual active buyers reached 867.3 million for the 12 months ending on September 30. Over the quarter, average MAU increased to 741.5 million. Pinduoduo turned 6 last month. We are grateful for opportunities to serve our users, farmers, merchants, and everyone who has interacted with us in the past 6 years, and we hope to continue serving them. It has been over a year since I took over as CEO and half a year as Chairman of the Board. Over this period, we have been busy with our transition, which I'm happy to report has been gradual and on track. There are two major developments in this transition that have been happening behind the scenes. The first is grooming younger talent and leaders. The second is shifting to more focused investments in R&D from a previous focus on sales and marketing for the first five years. Now let me elaborate. First, on grooming younger talent and leaders. Since the beginning of last year, we have witnessed many of our younger team members stepping up to take more responsibility. These young men and women demonstrated their core value of commitment to our users. When COVID-19 disrupted our daily lives, many among our young team immediately took actions to source essential supplies and deliver them to users in need. When heavy rains struck Henan in July, they coordinated sourcing of our stocks and logistics to ensure that our users would not run out of daily necessities. This unforeseeable event has accelerated their maturity and sent our supplies to our users and suppliers. We are encouraged to see more potential future leaders emerging from this young team. They have made practical business decisions that have exceeded our expectations. I'm proud to work alongside this young team. Despite their age, many of them have been with the company for a number of years and have matured on the job, shaping the future of this company. Young talent brings great creativity, vigor, and constant innovation. I see them taking a critical role over the next 6 to 12 months as we continue to create opportunities for them to step up. The second area is our shift to more focused investments in research and development. We are already serving 867 million users. To leverage our strength of having a management team with years of engineering training, we will be increasing our research development investments. This is a significant shift in strategy from our first five years when we focused more on sales and marketing. Agriculture has been an essential part and the backbone of our business since the very beginning, as we saw an opportunity to create value by incorporating agriculture into a digital economy. Trained as engineers, my team and I have devoted ourselves to finding technology solutions to implement across the agriculture supply chain. We have only scratched the surface after 6 years. There is still much more for us to do in agriculture, especially with technology. Therefore, we plan to deepen our investment in tech-enabled agriculture solutions to address critical needs in these sectors. This includes, first, bringing more agricultural products and agricultural communities into a digital economy; and second, further improving efficiency in agriculture supply chains to meet user demand and reduce waste. Over the past 6 years, Pinduoduo has provided consumers across China with a wider variety of agricultural products at better prices while helping farmers increase their income. When we started 6 years ago, we were among the first to sell agricultural produce online. We are now connecting 16 million farmers to 867.3 million consumers nationwide. During China's Golden Week in October, agricultural-related orders on our platform surged 279% compared to the same period last year. We hope Pinduoduo will be the go-to platform for quality agricultural products for farmers and consumers. We look forward to leveraging our platform to help more farmers improve their livelihood and benefit their communities. To this end, we will continue to focus on digital inclusion in the agriculture industry. We will expand our core offerings to scale farmers in e-commerce and store operations. This helps them control price and quantity in a way that they can manage directly as they sell to consumers. In order to expedite agriculture digitization, we plan to maintain our zero-commission policy on agricultural products. At the same time, we will continue to improve consumer awareness and appreciation of agricultural produce, geographical indications, and agricultural brands through technology innovations, such as live streaming, media marketing, etc. The more awareness consumers have, the more educated farmers will be, and the more value can be created for agriculture communities in China. We are also designing tech-enabled services to increase supply chain efficiency in the agriculture sector. One of them is to manage local supply with local demand. At the same time, we aim to reduce unnecessary transit to provide faster options for consumers. To further cut down transportation time and reduce food waste, we are developing proprietary technology solutions like load planning, analytics, and optimization. This solution helps lay the foundation for an infrastructure that is more sensible for agricultural products and more environmentally sustainable. Our efforts to apply agricultural technology go beyond matching supply and demand and extend to identifying upstream technology solutions to improve productivity, nutritional profiles, and environmental sustainability. By strengthening agri-tech applications, we also hope to make agriculture attractive to a tech-savvy younger generation. A good example of our efforts in this area is our Smart Agriculture Competition. It has demonstrated that precision farming techniques can lead to real improvements in farm output. Some contestants from our competition last year have started to commercialize their technology in strawberry cultivation, providing tangible productivity gains to farmers. This year, we have partnered with China Agricultural University and Zhejiang University, leveraging technical guidance from UN Food and Agriculture Organization and Zhejiang University. In line with our priorities, we're expanding the challenge to accept not just yield, but also nutritional value, environmental sustainability, and commercial viability. Contestants will take a multidisciplinary approach, applying nutrition science and precision farming to cultivate tomatoes. The financial team will have a cross-disciplinary background. Revenue from agricultural products is critical. Currently, they are remotely planting tomatoes in our smart greenhouse based in Hunan. We're encouraged to see that 80% of the team members are in their 20s, bringing energy and new ideas to a traditional agriculture sector. At the same time, we are partnering with world-class agricultural institutes to offer these young agri-tech talents tailored courses and training on topics such as greenhouse horticulture, product management, and modeling. Agriculture is an industry with great potential for young people who are the future of technology and aspire to make an impact on society. As an agri-focused platform, we want to leverage our platform and technology to provide more opportunities for young talents to join the agricultural sector, working with them to apply technology to improve every link of the agriculture supply chain. Investing in technology to improve agriculture sectors is a challenging task. It implies our long-term commitment, and we will be patient and systematic. We hope that through our efforts, we can help build a smarter and more sustainable future for agriculture. Last quarter, we announced the launch of our 10 billion agriculture initiative, which seeks to address critical needs in the agricultural sector and rural areas. This initiative will not be driven by profit or commercial goals, but rather aims to facilitate the advancement of agritech, promote digital inclusion, and provide agritech talent with greater motivation and a sense of achievement. Profits from the second quarter and any potential profits in future quarters will be allocated to this initiative until the final goal of 10 billion is met. The profit for the third quarter will also be invested into this initiative. After receiving Board approval at the end of September, we held an EGM, and the initiative was approved by our shareholders. Pinduoduo is closely connected to the community where we operate. This point is crucial to our development, and we intend to support them to the best of our ability. Therefore, we are committed to taking on more responsibility to society. In July, we plunged into action by donating RMB 100 million to flood relief and launching a portal to support emergency relief distribution. Our total grocery network provided a stock of food and emergency supplies and worked with suppliers to secure and distribute necessities to our nearly 20,000 partners there. In October, we also contributed to the relief effort in response to the heavy rain, donating RMB 50 million to the Shaanxi Charity Foundation to facilitate emergency disaster relief and post-disaster reconstruction work. Looking forward, we plan to do more to contribute to society. We will continue to proactively leverage our platform and resources to serve our users, farmers, merchants, and their communities better. Thank you. Now let me pass it on to Tony.

Tony Ma, VP of Finance

Thank you, Lei. Hello, everyone. Let me begin by sharing highlights of some of our agriculture initiatives in the past quarter. Then I will discuss our financials for the quarter. First, as part of our efforts for the digital inclusion of farmers, we initiated and supported a series of agricultural promotion activities to strengthen the direct connection between farmers and consumers. Autumn is a harvest season. This September, we were the main platform for the farmers' harvest festival and the golden autumn consumption season. We launched the Duo Duo Harvest Hall and designed a series of initiatives to help farmers sell better, including live streaming, merchant training, traffic support, etc. Over 280,000 agri-merchants participated in our event this year, nearly double the number last year. In September, we joined the Ministry of Agriculture and Rural Affairs Farmers Daily and the China Green Food Development Center to kick off the 2021 campaign of China's GI Agricultural Products Tour. The campaign helps to promote agricultural products and their regional heritage, recognizing quality agricultural products across China. To support the campaign, we provided technical and platform support. We offered online and offline training, including marketing and branding techniques tailored to GI products. During China's Golden Week in October, a period when families typically reunite and enjoy meals together, we rolled out various initiatives to make more agricultural products across the nation easily accessible through our platform. These initiatives helped to increase agriculture-related orders, which surged 279% over the same period last year. Second, we are stepping up efforts to raise consumer awareness, appreciation, and demand for quality agricultural produce in the producing regions. In October, we launched our Apple Golden Week. We worked with farmers in 6 major apple-producing regions: Shanxi, Shandong, Gansu, Sichuan, and Xinjiang to develop a grading and direct distribution framework. This framework helps provide consumers with delicious and high-quality apples and build awareness of the origins of these apples. As part of this initiative, our fruit selection team stationed in these regions for months to study local markets and help train high-quality apple merchants with strong supply chain capabilities. Alongside these efforts, we are also collaborating with research institutes to implement industry standards for agricultural products. We partnered with the Jiangsu Freshwater Fishery Research Institute to establish industry standards for Chinese meat and crops. These standards cover quality, size, packaging, and transport, providing consumers with a clear basis to make informed decisions about their purchases. We hope to help farmers promote their products, better meet the demand and expectations of consumers for quality goods and services, and build a sustainable business on our platform. Therefore, we will continue to maintain our zero-commission policy for agricultural products. Now let me walk through our third-quarter results. Our annual active buyers for the last 12 months ending September 30, 2021, increased to 867.3 million, up 17.4 million from the prior quarter. Our MAU in Q3 reached 741.5 million. This is up 15% compared to the same quarter in 2020. Given our current scale, our user growth will inevitably be more moderate going forward. At the same time, as we serve our larger user base, we also face more diversified and evolving user needs. Our task has become increasingly difficult. We hope that our younger team leaders will embrace these challenges and continue to serve users' needs innovatively. In terms of P&L, our total revenues in the quarter ending September 30, 2021, were RMB 21.5 billion, up 51% from RMB 14.2 billion in the same quarter last year. Excluding revenues from our 1P trials, our total revenue grew by 55% to RMB 21.4 billion in Q3 2021, with online marketing services as the key driver. Online marketing services revenue was RMB 17.9 billion this quarter, up 44% compared to the same period last year, primarily due to the increase in merchant activities. Our transaction service revenues this quarter amounted to RMB 3.5 billion, which is up 161% compared with the same period last year. The increase in our transaction service revenues was due to two primary factors: first, the increase in transaction processing fees; second, the service revenues we recognized in connection with Duo Duo Grocery, for which we provided fulfillment and other related services. Revenue from the merchandise sales from our 1P trials was RMB 80.1 million in Q3 2021, compared to RMB 2 billion in the preceding quarter. Our 1P business was a temporary solution to meet the demands of our users for products that our merchants could not fulfill. As we see more product offerings from our merchants, we expect the contribution from 1P trials to be insignificant. Now moving on to costs and expenses. Our total cost of revenues increased from RMB 3.3 billion in Q3 2020 to RMB 6.6 billion this quarter. The increase was primarily due to higher costs of payment processing fees, cloud services fees, and delivery and storage fees. Total operating expenses this quarter were RMB 12.8 billion, compared to RMB 12.2 billion in the same quarter of 2020. On a non-GAAP basis, our operating expenses were RMB 11.7 billion, compared to RMB 11.3 billion in the same quarter a year ago. Our non-GAAP sales and marketing expenses this quarter were RMB 9.7 billion, decreasing 1% compared to the same quarter of 2020. On a non-GAAP basis, our sales and marketing expenses as a percentage of our revenues this quarter was about 45%, compared to 89% and 69% for the same quarter in 2019 and in 2020. The continued reduction in sales and marketing expenses as a percentage of revenue reflects our efforts to proactively reduce sales and marketing expenses as we gravitate toward more investments in R&D. Our non-GAAP general and administrative expenses were RMB 178.1 million compared to RMB 132.6 million in the same quarter of 2020. Our non-GAAP research and development expenses were RMB 1.9 billion, an increase of 30% from RMB 1.4 billion in the same quarter of 2020. This increase in R&D spending was primarily due to an increase in headcount and the recruitment of more experienced R&D personnel. As we continue to strengthen our technical capabilities to lay the foundation for sustainable growth and improve our services to meet evolving user demand, we are committed to expanding our investments in R&D and expect continued growth in R&D expenses. To sum up, operating profit for the quarter was RMB 2.1 billion on a GAAP basis compared with an operating loss of RMB 1.3 billion in the same quarter of 2020. Non-GAAP operating profit was RMB 3.3 billion, compared with an operating loss of RMB 339.8 million in the same quarter of 2020. Our non-GAAP operating profit as a percentage of our revenue improved from minus 2.4% in Q3 2020 to 15.2% in Q3 2021. Net income attributable to ordinary shareholders was RMB 1.6 billion compared to a net loss of RMB 784.7 million in the same quarter last year. Basic earnings per ADS was RMB 1.31 and diluted earnings per ADS was RMB 1.15 compared with basic and diluted net loss per ADS of RMB 0.66 in the same quarter of 2020. Non-GAAP net income attributable to ordinary shareholders was RMB 3.2 billion compared with net income of RMB 466.4 million in the same quarter last year. Non-GAAP diluted earnings per ADS were RMB 2.18 compared with non-GAAP diluted net earnings per ADS of RMB 0.33 in the same quarter of 2020. In August, we announced the launch of the 10 Billion Agriculture Initiative, which aims to address the critical needs in the agricultural sector and rural areas. The initiative will not be driven by profit or commercial goals, but will strive to facilitate the advancement of agritech, promote digital inclusion, and provide agritech talent with greater motivation and a sense of achievement. The initiative received shareholders' approval at the AGM held at the end of September. Profits from the third quarter will also be allocated to this initiative. We expect the initiative to have a near-term impact on earnings per share for shareholders. That completes the profit and loss statement for the third quarter. Net cash flow provided by operating activities was RMB 8.7 billion, compared with RMB 8.3 billion in the same quarter of 2020. As of September 30, 2021, the company had RMB 97.9 billion in cash, cash equivalents, and short-term investments. With that, I conclude my prepared remarks.

Chung Khoan, Unidentified Company Representative

Thank you, Tony. For today's Q&A session, we have Lei, our Chairman and Chief Executive Officer; and Tony, our VP of Finance on the line. Preston will help translate Lei's remarks in Chinese to English for ease of reference. Operator, we may now take questions from the first analyst on the line.

Operator, Operator

Your first question comes from Natalie Wu of Haitong International. Please go ahead with your question.

Natalie Wu, Analyst

Hi, good evening. Thanks for taking my question. I have two questions here. First of all, it seems that your sales and marketing expenses are tapering off. Just wondering, are you changing your ROI for sales and marketing spending? How should investors understand your future sales and marketing strategies? This is also the second consecutive quarter that your company is showing both non-GAAP and GAAP profit. Just wondering, are you prioritizing profitability over growth going forward? Should the investors expect full-year profitability for 2021 and beyond? And my second question is regarding the agriculture initiatives. Just wondering, can you provide an update on the CNY 10 billion initiative you started last quarter? Have any investments been reflected in the latest financial results? Which financial line items have been affected? Thank you.

Chen Lei, CEO

Thank you, Natalie, for the question. To answer your question, our high standards for sales and marketing investments ROI have not changed. But as our user base expands and our user needs diversify, we are also constantly adjusting our ROI model. The goal is to better serve our users' diversified demands. When we were just starting, we aimed to attract more users to get to know us and try our platform. Now that our user base is much larger, our new challenge is how to encourage them to try new categories and explore new experiences while meeting their changing expectations. It's a challenging task, especially given the size and diversity of our user base. However, we remain committed to high ROI standards for our sales and marketing and are disciplined in our spending. At the same time, we are stepping up our investments and being patient for long-term development. You may have noticed that we are increasing our R&D investments, which is a key area for our future investments. Tony, can you address the profitability question?

Tony Ma, VP of Finance

Okay. Natalie, regarding the consecutive profitability over the past two quarters, the main contribution to our profitability in these quarters is the leverage efforts from our sales and marketing expenses showing a decline as a percentage of revenue. Profitability is not one of our internal KPIs; instead, we focus on long-term investments to meet users’ fundamental needs. Investment in sales and marketing is akin to capital expenditure for us as we aim to build long-term user trust and assets. We are shifting our focus to R&D and expect increased investment in this area. Regarding your second question about the CNY 10 billion initiative, this program only received the EGM approval at the end of September. Consequently, there is nothing reflected in Q3 financial results yet. Lei, I'll pass it back to you.

Chen Lei, CEO

I'd like to add one more point here. After we announced our CNY 10 billion agri initiative last quarter, we received many quality proposals and ideas from various industry stakeholders. Together with my team, we are analyzing various proposals. That concludes the answer to this question.

Natalie Wu, Analyst

Got it, very clear. Thank you, Lei and Tony.

Operator, Operator

Your next question comes from the line of Thomas Chong of Jefferies. Please ask your question.

Thomas Chong, Analyst

Hi, good evening. Thanks, management, for taking my questions. I have two questions. The first question is about the competitive landscape in online shopping as well as the impact on your site due to the increase in popularity of live streaming online shopping. My second question is about our support measures. Can management highlight our support measures? How should we expect the growth rate between GMV and advertising due to these support measures? Thank you.

Chen Lei, CEO

Thank you, Thomas, for your question. Let me address this. E-commerce in China is a huge, vibrant, and potential-rich industry. With the continued development of mobile technologies, infrastructure, and consumer demand, we expect more platforms to enter this space, which makes commercial sense. Additionally, the recently issued rules and regulatory measures are promoting healthy competition and orderly development in the entire e-commerce sector. In our view, more competition is beneficial, providing advantages to users and the industry overall. We have seen many platforms, including short video ones, entering our sector. However, what's essential is how we can deliver meaningful value to our nearly 870 million users. Our primary concern is how we can better serve them and also create societal value. We continually ask ourselves how we can iterate to meet user needs. Our key strategy remains about gaining user trust and creating value for society, which we believe will also serve as our long-term assets.

Thomas Chong, Analyst

My next question is about our support measures to merchants and how we should think about the growth rate between GMV and advertising due to these support measures. Thank you.

Tony Ma, VP of Finance

Thank you, Thomas. Your question relates to the outlook for monetization. Our strategy has always been serving our users well, as Lei just mentioned. We believe that revenue growth and monetization are natural results of that. Our merchants’ ROI is already reflected in our revenues. Our revenue this quarter shows the healthy ROI that merchants are experiencing when they sell more on our platform. Our focus is not solely on quarterly monetization; instead, it results from user satisfaction and merchant ROI. Our monetization rate has fluctuated in the past and will likely do so going forward. We are committed to raising the standards for our merchants and products to meet users' needs while promoting agricultural products, therefore maintaining our zero commission policy for agriculture and fresh produce.

Eddy Wang, Analyst

Thank you, Lei and Tony, for taking my question. I also have two questions. The first is regarding our efforts to attract more branded products and merchants on our platform. We noticed that the merchandise sales declined significantly on a quarter-on-quarter basis. Should we suppose that this is a positive indication of attracting more branded products in the last quarter? My second question is about the rather weak consumption environment in China since the third quarter. Some of our competitor platforms have been significantly affected by this weak consumption; however, we seem to be highly resilient. I would like to hear your view on how this weak consumption has affected PDD, especially given that we have higher exposure to agricultural products and value for money. Does that mean our GMV growth or revenue growth is more resilient under this environment? Thank you.

Chen Lei, CEO

Let me answer your question. I believe your first question is about brands. As our user base increases, we observe that our users’ needs and demands are diversifying. Our users require a more abundant supply of product offerings and brands. Gaining more brands is a gradual process that necessitates both the platform and the brands investing resources, time, and energy to build trust and foster successful partnerships. While we anticipate progress, this process will take time. Regarding the impact of weak consumption on Pinduoduo, we think that our strong ties to agricultural products and the value for money that we offer render us somewhat resilient. Hence, our GMV growth has been more stable despite the prevailing environment.

Operator, Operator

Please hold, and the conference will resume shortly. Thank you for your patience. Your next question comes from Joyce Ju of Bank of America. Please ask your question.

Joyce Ju, Analyst

Thank you, management, for the opportunity to ask my questions. I have two questions. The first question relates to the regulatory environment. Could management give us an update on the recent regulatory environment, specifically the impact of Tencent and Alibaba's opening on our operations? Can you also share any insights on regulatory measures affecting your operations? My second question is we have seen our 1P business continue to decline in the third quarter. Does this mean that you have wound down this business? Any comments on the future contributions of the 1P business? Thank you.

Chen Lei, CEO

We believe that the recent series of regulatory measures will help promote high-quality growth for both our platform and the industry overall. We have always embraced and supported regulatory measures and will continue to implement all relevant guidance thoroughly. Many companies are taking action to optimize under these changes imposed by regulations in the industry, and we are among those companies. Although there may be short-term impacts from these changes, we believe that in the medium to long term, these changes will be beneficial for users, the industry, and the companies involved.

Tony Ma, VP of Finance

Joyce, let me address your question regarding the 1P business. We have stated that our 1P trial was a temporary measure to serve products our consumers wanted but that our merchants could not fulfill at the time. Therefore, 1P is not a strategic priority for us. As more products are being offered by merchants on our platform, we do not expect significant revenue contributions from the 1P business going forward.

Chung Khoan, Unidentified Company Representative

Thank you, everyone, for joining us on the conference call today. If you have any further questions, please refer to our IR team managers. Thank you, and have a great day.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.