Earnings Call Transcript - PDD Q2 2022

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to Pinduoduo's Second 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.

Chen Pang, 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. Pinduoduo's earnings release was distributed earlier and is available on the IR website at investor.pinduoduo.com, as well 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. 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 second quarter ended June 30, 2022. During the Q&A session, Lei will answer questions in Chinese, and I will help translate. Please kindly 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.

Chen Lei, Chairman and CEO

Thank you, Chen, and hello, everyone. Thank you for joining our earnings call in the second quarter of 2022. Let me start by giving a brief overview of our second quarter results. Our total revenue for this quarter was RMB 31.4 billion. This represents a year-on-year increase of 36%. We witnessed the resilience of China's consumption during the second quarter. After being temporarily affected in the early part of the quarter, pent-up demand was released and we returned to normal. Consumer sentiment gradually recovered in the second half of Q2. Since May, we launched several campaigns and distributed coupons to bolster consumer confidence. This recovery in consumer confidence was also reflected in a positive reception for this year's June 18 shopping festival. During the June 18 shopping festival, we continued to focus on bringing our customers more savings and more fun. We are encouraged to see consumers buying from a wide range of categories. For example, categories such as agriculture products, FMCG, household electronics, and cosmetics all experienced solid consumer demand during the festival. Also, more and more brands are partnering with us, and many use our platform to launch their new products. These are signs that consumers and merchants are finding value in our platform. That said, we still have a long way to go before fully meeting our consumers' evolving needs. Our business activities and investments were affected during the last quarter, especially in the first half. Short-term external factors such as remote working and travel restrictions caused delays to certain projects, including promotional events and Agritech initiatives. Even though this might make the quarterly financials look better, the long-term perspective of our platform may be affected, especially considering the current industry dynamics. Therefore, it has become more important than ever to step up our investments and build up our core capabilities. We must make every possible improvement and create value for our consumers, business partners, and society. For consumers, we are constantly on the lookout for new unmet needs and iterating our services to meet those needs. For example, during April, we saw a spike in consumer demand for fresh food, groceries, and daily necessities in Shanghai. To meet this demand, we set up a special section in the Pinduoduo app for residents to buy fresh food and essential items and have them delivered within 48 hours. From the initial 25 items, we quickly expanded the selection to around 300 products, from essentials like rice and cooking oil to diapers and hygiene products. Given the surge in demand and limited logistical capacity, we also offered more delivery flexibility through pooling of orders by housing community. Here, we would like to express our gratitude to the colleagues who worked hard to ensure the operation of our platform in the past quarter. Their hard work served many consumers in their time of need, and we are deeply thankful and proud of their contribution. Things gradually returned to normal. We also launched various events to promote seasonal agricultural produce. For instance, in late May, in response to consumer demand, we launched a campaign to help consumers discover and enjoy seasonal foods from across the country. This event was well received by consumers. Sales of lychees surged 158% compared with a year ago, while orders increased significantly for other foods such as watermelon, coconut, and grapes. Seeing consumer feedback, we rolled out a year-long fresh produce of China initiative together with local newspapers. This initiative will introduce the unique characteristics of different agricultural specialties across the country to our consumers and contribute to better income for local farmers. For merchants, we worked closely with them to ensure stable supply, especially at the start of the quarter, where the supply chain was affected. For example, we proactively provided traffic updates to help our merchants better plan and adjust their logistics. We also launched special campaigns and measures to support small and medium-sized businesses and agricultural merchants on our platform. For example, our grocery operations quickly contacted local suppliers, where we learned that farmers in certain regions were unable to sell their vegetables due to traffic disruption. Within a short period, they managed to sell hundreds of tons of vegetables through our platform, directly helping farmers avoid financial losses. To support our farmer merchants, we will continue to waive the sales commissions of agricultural products. As a technology company with roots in agriculture, we firmly believe that technology can serve as a force for good. We see rural communities benefiting from agricultural e-commerce, such as new jobs and higher income. Young people now have the opportunity to start their own online businesses in their hometown and stay close to their families. These benefits are both economic and social, tangible and intangible. We mentioned before that we have trained hundreds of thousands of new farmers, supporting them to set up online businesses and helping their local communities to sell their produce. In addition to farming, we hope to further unleash the vitality of the rural economy by starting the new craftsmen program. As with agriculture, we aim to help local artisans and craftsmen promote traditional craft, build their brands, and widen their access to market. We also expanded our Duoduo Reading Month campaign to promote the love of reading among young students in rural areas. As of today, we have donated over 250,000 carefully selected books. We hope that through such efforts, we can do our part in contributing to a better future for today’s youth. To conclude, as we deal with trends from quarter to quarter, we remain focused on building long-term intrinsic value and investing for the future. We will stick closely to our core principles of benefiting all people first and being more open, and we stay committed to building a platform that serves as a force for good. Thank you. With that, I will hand over to Jun.

Liu Jun, VP of Finance

Thank you, Lei. Hello, everyone. I will go through our performance in the quarter ended June 30, 2022. In terms of P&L, our total revenue in the quarter was RMB31.4 billion, up 36% from RMB23 billion in the same quarter of 2021. This was mainly driven by an increase in revenues from online marketing services and transaction services, offset by the decrease in revenue from 1P trials. Revenues from online marketing services and others were RMB25.2 billion this quarter, up 39% compared with the same period of 2021. This was primarily due to an increase in merchant activities, as a result of consumption recovery. As Lei has mentioned, we experienced recovery in consumer sentiment in the latter part of the quarter, especially during the June 18 shopping festival. Our transaction services revenue this quarter was RMB6.2 billion, up 107% versus the same period of 2021. Moving on to costs and expenses, our total cost of revenue increased 1% from RMB7.9 billion in Q2 2021 to RMB8 billion this quarter. Total operating expenses this quarter were RMB14.8 billion versus RMB13.2 billion in the same quarter of 2021. The postponement of certain projects, including promotional events and agricultural initiatives, as well as lower business-related expenses during the first half of the quarter, temporarily affected our overall expenses. As things gradually returned to normal, we incurred more expenses in the second half of this quarter. Our total non-GAAP operating expenses as a percentage of total revenues have declined from 52% in Q2 2021 to 41% in this quarter. Looking at specific expense items, our non-GAAP sales and marketing expenses were RMB10.8 billion, up 8% versus the same quarter of 2021. On a non-GAAP basis, our sales and marketing expenses as a percentage of our revenue this quarter was 34% compared with 43% for the same quarter in 2021. Our non-GAAP general and administrative expenses were RMB164.7 million versus RMB213.8 million in the same quarter of 2021. Our non-GAAP research and development expenses were RMB1.9 billion, an increase of 11% from RMB1.8 billion in the same quarter of 2021. The increase was primarily due to an increase in headcount and the recruitment of more experienced R&D personnel. Operating profit for the quarter was RMB8.7 billion on a GAAP basis compared with operating profit of RMB2 billion in the same quarter of 2021. Non-GAAP operating profit was RMB10.5 billion versus the operating profit of RMB3.2 billion in the same quarter of 2021. Net income attributable to ordinary shareholders was RMB8.9 billion, compared with RMB2.4 billion in the same quarter of 2021. Basic earnings per ADS was RMB7.06 and the diluted earnings per ADS was RMB6.22 versus basic earnings per ADS of RMB1.93 and diluted earnings per ADS of RMB1.69 in the same quarter of 2021. Non-GAAP net income attributable to ordinary shareholders was RMB10.8 billion, compared with RMB4.1 billion in the same quarter last year. Net non-GAAP diluted earnings per ADS was RMB7.54 versus RMB2.85 in the same quarter of 2021. Now let me move on to cash flow. Our net cash flow generated from operating activities was RMB19.4 billion, compared with RMB7.4 billion in the same quarter of 2021, primarily due to the increase in net income and changes in working capital. As of June 30, 2022, the company had RMB119.4 billion in cash, cash equivalents, and short-term investments. To conclude, profitability in the past quarter was mainly attributable to a few short-term factors that may not repeat in the future. But we saw good user engagement during the past quarter. As competition remains intense, we're not sure whether such engagement momentum will continue. Second, project performance and lower business-related activities affected our overall expenses in Q2. We view this factor as mostly temporary in nature. In fact, we incurred higher expenses in the second half of Q2 when things returned to normal. Therefore, even if profits in the second quarter are mainly due to a combination of several short-term factors, we do not expect profitability in the first quarter to serve as a benchmark for future quarters. Thank you. This concludes my prepared remarks.

Chen Pang, Company Representative

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 are happy to take a maximum of two questions per analyst. Lei will answer questions in Chinese, and I will help to translate his remarks for ease of reference. Operator, we are now ready to take questions from analysts online.

Operator, Operator

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. Our first question comes from Kenneth Fong from Credit Suisse. Please go ahead.

Kenneth Fong, Analyst

I have two questions. First, on the second quarter growth rate, we noticed very strong online marketing service revenue that recorded a strong growth of 39% year-on-year. This reaccelerated from the previous two quarters. What's the reason behind this quarter's strong growth? And the second question is about the brands. Can management speak more about the progress on bringing more brands onto our platform? We saw many brands participate in our future events. How does this help our growth for this quarter? And what's your overall plan for the brand recruitment? Thank you.

Chen Lei, Chairman and CEO

Kenneth, I am happy to take your questions. First, regarding our revenue growth, starting from the second half of May, we saw a trend of consumption recovery. Also, we made efforts to facilitate consumer spending by offering various forms of promotion to help with consumption recovery. During this year's June 18 event, we saw very active participation from merchants and brands, and we also observed solid demand coming from consumers. Given this backdrop on our platform, many categories, including FMCG products, agricultural produce, consumer electronics, and cosmetics, all experienced decent growth. Additionally, we always strive to satisfy consumer demand, and this is inseparable from the hard work of many of our team members during this period. They worked very hard to help many consumers meet their essential needs, and we are grateful for our team's hard work during this process. At the same time, we also see that competition in the landscape is still very intense. In terms of satisfied consumers' needs, we have many areas where we can further improve. As I mentioned earlier, due to external factors, our overall investment activity during the second quarter was impacted and this is not beneficial to our long-term competitiveness. Therefore, we need to further step up our efforts and strengthen our core capabilities so that we can create more value for consumers and for society.

Kenneth Fong, Analyst

And during this year's June 18 event, we saw many merchants as well as brands actively participating. We also saw solid demand coming from consumers. What is your overall plan for the brand recruitment?

Chen Lei, Chairman and CEO

As for your second question regarding our brand strategy, we see that the needs from our consumers on our platform are becoming more diversified. Different consumers have different needs in various product categories and across different consumption scenarios. Therefore, it is very natural for them to need more choices and more products. Our goal is always to better serve our consumers and to bring them more savings and a better shopping experience. Essentially, the goals of the brands and ours are well aligned, which is to serve consumers effectively. Thus, we will continue to focus on our part and remain very grounded and patient.

Operator, Operator

Next question comes from Joyce from Bank of America. Please ask your question.

Joyce Ju, Analyst

Good evening management. Thanks for taking my questions. My first question is related to the overseas expansion. Could management share some insights on the reported new initiatives in the overseas market? What's the latest status, any main target market, and what's the core value proposition of this new business? My second question is related to the transaction service revenue. Transaction service revenue continued to grow faster than the online marketing revenue this quarter, accelerating to triple-digit year-over-year growth. Can you explain the reason behind this?

Chen Lei, Chairman and CEO

Let me address your first question regarding our overseas business. We are a young company with a relatively young team, and everyone is continuously growing and searching for new opportunities during our growth process. The overseas business is one of the opportunities that we see, and we also identify potential for creating value in this area. However, we understand that many peers in the industry have achieved good results, and we believe it is a direction worth pursuing. It's important to note that we will not merely replicate what others have done in this field. We will start from the needs of consumers and strive to create our own unique value. We are mindful that the overseas business will, of course, present challenges and will require constant trials and experimentation. This process will not occur overnight, but the experience gained along the way will prove to be invaluable for our company and our team.

Liu Jun, VP of Finance

Okay. Thanks for your question, Joyce. Regarding your question about transaction services revenue, we always remain consumer-centric. Operating metrics and financial metrics are natural results from how we serve our consumers. Over the past quarter, due to consumption recovery, we achieved user engagement and transactions that contributed to revenue growth. Additionally, our business cycle does not always align exactly with our quarterly financial reporting cycle. We are not managing our business on a quarterly basis, so it's common to see fluctuations between quarters. We remain focused on serving consumers better and investing to create long-term value.

Operator, Operator

We are ready to move on to the next analyst down the line.

Thomas Chong, Analyst

Thanks management for taking my question. My first question is about cost control and efficiencies, given the macro uncertainties right now. We are seeing a lot of Internet companies exercising cost control. I want to get some color from management about our cost control strategies. My second question is about our profitability. Given that the second quarter earnings came in better than expected market expectations, how should we think about the profitability trend in the second half? Thank you.

Chen Lei, Chairman and CEO

Let me address your first question. First of all, I believe that we are still in the development stage, not the stabilization stage. At this point, we still have a lot to do to serve our consumers well. As part of our development, continually satisfying consumer demand requires a lot of patience. We need to constantly explore and seize key opportunities, as well as make the necessary investments. During the past quarter and especially in the first half, our team's investment activities were impacted. While this might bring decent short-term financial results, looking at it from a long-term perspective, it weakens our competitiveness. Thus, we will always think about the long-term and remain committed to investing for the future. We need to enhance our core capabilities and continue to invest in agriculture and R&D over the long term to create value for consumers and for society. This will support our long-term, high-quality development.

Liu Jun, VP of Finance

Thanks, Thomas. I will take your second question, regarding profits. Our profitability in the past quarter was mainly attributable to a number of external factors, mostly short-term or one-off in nature. On the revenue side, we enjoyed a good level of user engagement and consumption, largely boosted by recovery. That said, we do confront very intense competition. On the expense side, project delays and a reduction in business-related activities led to the short-term impacts of our Q2 expenses. In summary, this quarter's profitability resulted from short-term factors, and it may not be a reliable benchmark for future performance. Thank you.

Operator, Operator

Next question comes from Bai Yang from CICC. Please ask your question.

Bai Yang, Analyst

Thanks management for taking my question. My first question is about Duo Duo Grocery. We are seeing that Duo Duo Grocery is reaching a relatively steady growth state and players guided about loss reduction on unit economics. Can management share some color on the future prospects of Duo Duo Grocery? Are we also focusing more on efficiency measures? How will the increase in Duo Duo Grocery financial leverage contribute to the firm’s level margin this quarter? My second question is regarding the operating expense ratio. As revenue continues to grow and the operating leverage continues to play its role, the company's expense ratio has dropped to 47%. Should we expect this situation to be sustainable? Meanwhile, we recorded a 36% year-over-year growth in revenue; could management comment on how we have managed to optimize expenses while maintaining strong growth? Thank you.

Chen Lei, Chairman and CEO

Let me first talk about Duo Duo Grocery. From a strategic perspective, Duo Duo Grocery is a natural extension of our platform. We aim to leverage our value proposition in agriculture to better serve consumers. This project is one we will patiently invest in. The timing of investments will not be impacted by external short-term changes. Since we introduced Duo Duo Grocery in the second half of 2020, we have identified important areas in matching localized demand with supply and fulfillment. This service provides consumers with fresher, more affordable, and convenient agricultural products, creating tangible value for consumers. Simultaneously, we see areas for improving total grocery service, such as matching supply and demand more efficiently, securing quality products, optimizing the distribution network, and further improving service quality. We are constantly adjusting and improving in all these areas to enhance service experience for our consumers. Remaining consumer-centric is our top priority, and this will never change; we are committed to creating value for our consumers.

Liu Jun, VP of Finance

Thanks, Bai. On your question about the trend of operating expenses, our total operating expenses as a percentage of revenue dropped to 47% this quarter as you pointed out. I want to highlight that several short-term factors, such as project delays and reduced business activities caused this decrease, so it is unlikely to continue. In fact, as conditions gradually normalize, expenses during the second half of the quarter actually increased compared to the first half. Thus, Q2's expenses may not serve as a good benchmark. Additionally, as Lei previously mentioned, Pinduoduo is still in the development stage, and this impact on our investments is not advantageous for us from a business standpoint. The competition remains fierce and we need to continue investing for future growth.

Chen Pang, Company Representative

Hi, operator. We may now take questions from the next analyst on the line.

Natalie Wu, Analyst

Thanks for my question. I have two. First one regarding the department priorities; we have seen some time since earlier on your leadership and started to shift toward agriculture program and R&D. However, we haven't seen much material impact in terms of the income generated from the 10 billion agricultural program. How have such priorities changed? Can we expect a change when external factors differ? For example, as the consumer segment improves, will you prioritize platform-related sales and marketing? What are your current key priorities to bring PDD to the next level? It would be great if we could get a sense of your internal strategic priorities for platform e-commerce, agriculture, and new initiatives related to overseas expansion. Also, you have a strong balance sheet with over RMB 100 billion in terms of cash. We have seen some peers introduce plans to distribute value to shareholders. Does PDD have similar plans under consideration? Thank you.

Chen Lei, Chairman and CEO

Let me address your question regarding priorities. We need to look at the foundation of our business and from where we start. We are dedicated to serving rapidly evolving consumer needs, and our development is tied to our consumers' support—this is our duty as a company. As our user base grows, it is essential we better serve them while deepening their trust in Pinduoduo and increasing their mind share. Toward this goal, we have shifted our focus to agriculture and R&D, which remains our priority. We find that investment in these areas can yield tangible value for consumers and society. In terms of agriculture, we enhance online transactions to allow consumers to enjoy fresher food efficiently. We also facilitate technology adoption to aid farmers in improving yield and stable income. By strengthening our R&D capabilities, we better understand consumer demands and preferences to enhance their shopping experience and create more value. Our team members are growing through their responsibilities and ensuring stable platform operation, helping to meet consumer demand and create social value. We will offer more opportunities for them to grow and take on responsibilities. We are still in the development stage, and we need to keep investing patiently to improve our team's capabilities to serve consumers better.

Liu Jun, VP of Finance

Thanks, Natalie. I’ll take your second question related to cash balance and capital allocation. Given the current competitive landscape and challenges, there are still many areas where we can improve to better meet consumer demand. This includes purchasing and R&D, so we need to invest patiently in these areas. Different companies may be at different stages of development. We have stated before that we are in an investment phase and will continue to focus on these areas to create long-term value.

Chen Lei, Chairman and CEO

Thank you, everyone, for joining us on the conference call today. Due to time limits, we hereby conclude the call now. If you have any further questions, please feel free to reach out to our IR team. Thank you and have a great day.

Liu Jun, VP of Finance

Thank you.

Operator, Operator

Ladies and gentlemen, this concludes our conference for today. Thank you for participating. You may all disconnect.