Earnings Call Transcript - PDD Q1 2022

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to Pinduoduo’s First 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 Penn. Sir, please go ahead.

Chen Penn, 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. Pinduoduo earnings release was distributed earlier and is available on IR website at investor.pinduoduo.com, 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. 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; Liu Jun, our VP of Finance. Lei will make some general remarks on our performance for the past quarter and our strategic focus going forward. Jun will then take us through our financial results for the first quarter ended March 31, 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 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, Chen. Hello, everyone. Thank you for joining our earnings call for the first quarter of 2022. Let me start by giving a brief overview of our first quarter results. Our total revenue for this quarter, excluding revenue from merchandise sales, was RMB23.7 billion. This represents a year-on-year increase of 39%. Our annual active buyers reached RMB881.9 million for 12 months ending on March 31, with RMB751.3 million average quarterly MAU. Given our current scale, our user growth will inevitably slow down. That's why we have shifted our priority from winning new users to how to better serve our existing user base. We also strive to adapt to the constantly evolving patterns of consumer behavior. There is still plenty of room for us to improve and we will continue to work hard to refine and strengthen our core capabilities. In all of this, agriculture continues to be the front and center of our strategy. We remain focused on making long-term investments in agriculture and promoting digital inclusion. A key plank of our strategy has been to develop a tech-driven agricultural infrastructure that is sustainable and can meet the needs of different stakeholders. We constantly think about how we can use our platform to create more value for our consumers and benefit society. And here, I would like to take this opportunity to express my thanks to our consumers, producers, merchants, and other partners for their continued support. We are grateful to them for standing with us as Pinduoduo matures as a company and takes on more social risk and quality. We are committed to serving all of them better. We are also grateful that Pinduoduo is in a position to serve millions of farmers and conduct them into a digital economy. We help farmers and more by promoting agricultural produce to more consumers across the country. This creates huge value for our consumers who can now enjoy high-quality fresh produce at low cost through our agricultural network. During the Chinese New Year period in the first quarter, we partnered with our merchants and logistics service providers to offer uninterrupted delivery services. Demand for high-quality agricultural produce surged during the period. We attracted orders from consumers who could not fulfill their needs previously due to lengthy delivery time, high cost, and wastage. Order volumes for different types of agricultural produce increased significantly during the Chinese New Year period. They include tariffs, oranges, seafood, and so on. Their relatively short shelf life and less supply had previously confined them to local regions; aided by our agricultural infrastructure, it now takes just a few hours for the fresh produce to arrive at warehouses. This has greatly shortened the time consumers have to wait to receive their fresh produce. As work continues on agricultural infrastructure, we are also pushing ahead on the technology front. Now, I'm happy to share with you some of the tangible results of our second Smart Agriculture Competition, a lot of distance to make a growing challenge that concluded in April. Over the last six months, we worked closely with China Agriculture University, Zhejiang University, the UN FAO, and Wageningen University to encourage young scientists and technologists to develop practical and cost-effective Agritech solutions that farmers can use to improve their livelihood. The participating teams have done very well in applying technology to solve real-world problems. First, they developed precision greenhouse management solutions that substantially improved crop production. The teams were able to deliver double the yields of traditional growers by addressing variables such as humidity and lighting. The nutritional value of the tomatoes also registered in the top range of the industry. These solutions are commercially viable and can be applied by growers without special training. Second, the R&D processes of participating teams diversified other practical technologies. For instance, one group of researchers developed a disease prediction model that gave farmers a one-week window to intervene and prevent loss. Another group came up with low-cost and environmentally-friendly equipment to enhance plant growth. The teams also made use of visual recognition technologies to help growers make better decisions on irrigation and harvesting. Their achievements demonstrate the benefit of technology when brought into agriculture. We are delighted that the competition is serving as a bridge between academia and industry to facilitate the implementation of effective technology. We will be supporting the teams as they roll out their solutions across China. We are also very encouraged that the competition has helped inspire young people from different disciplines and backgrounds to improve their work in agriculture. The majority of the participants in the Smart Agriculture Competition will continue their studies at Zhejiang University. Many have said they benefited greatly from interacting with world-class talent from different fields. They gained new perspectives and new knowledge to help advance their own work. Indeed, some participants in the competition come from a rural background. They agree with the firm belief that agritech will help secure our food supply and relieve the workload of farmers. We will share their insights to make agriculture better through technology. The future of agriculture will depend on attracting more of these tech-savvy individuals and channeling their passion into this sector. And on our part, Pinduoduo is ready to help facilitate their dreams. We believe that the digitalization of agriculture will unlock opportunities and efficiencies that will benefit society at large and the environment. We are committed to investing and working with like-minded partners on this important initiative. We will play a long game and aim for long-term success. This means being patient and evaluating initiatives according to their impact on agri-food ecosystems and future generations. To conclude, we started last year to transition from a phase of hyper-growth to one of more measured development. Our transition from sales and marketing towards research and development continues into 2022. We now have a technology team numbering over 5,600, which represents about 60% of our total workforce. They not only enhance and improve our technological capabilities but also help attract new talent. We will step up our efforts to further build up our in-house research and development capabilities. We continue to believe that this is the right approach at this stage of our development. We will do more and do better to achieve our long-term corporate mission to put people first, to be open, and to benefit all. Thank you. And now, let me pass the call to Jun.

Liu Jun, VP of Finance

Thank you, Lei. Hello, everyone. Let me first walk you through our operating results for the first quarter ended March 31, 2022. Our annual active buyers for the 12 months ending March 31, 2022, was 881.9 million. This is an increase of 58.1 million or 7% from the same quarter of 2021. Average MAU in Q1 was 751.3 million. This is a 26.7 million increase or 4% from the same quarter of 2021. At this current scale, it is inevitable for us to see slower user growth. We will continue to focus on how to serve our users better to deepen the trust users place in us and improve user mind share. Next, I will go through our financial performance for the quarter ended March 31, 2022. In terms of P&L, our total revenue in the quarter was RMB23.8 billion, up 7% from RMB22.2 billion in the same quarter of 2021. This was mainly driven by an increase in revenues from online marketing services and revenue from transaction services, offset by the decrease in revenue from 1P trials. Excluding revenue from our 1P trials, our total revenue was RMB23.7 billion in Q1 2022, up 39% from RMB17 billion in the same quarter of 2021. Revenues from online marketing services and others were RMB18.2 billion this quarter, up 29% compared with the same period of 2021. This was primarily due to an increase in merchant activities, a reflection of the value that our platform provides. Our transaction services revenue this quarter was RMB5.6 billion, up 91% versus the same period of 2021. The increase in our transaction services revenue was due to the higher total transaction processing fee as a result of higher transaction volume, and more diversified services that we provide to merchants such as fulfillment services. Moving on to cost and expenses, our total cost of revenue decreased from RMB10.7 billion in Q1 2021 to RMB7.2 billion this quarter. The decrease came mainly from the reduction of merchandise sales, partially offset by increased fulfillment expenses. Total operating expenses this quarter were RMB14.5 billion versus RMB15.6 billion in the same quarter of 2021. On a non-GAAP basis, our total operating expenses as a percentage of revenue, excluding 1P, has been declined from 86% to 55% for Q1 of 2021 and 2022, respectively. Looking to specific expense items, our non-GAAP sales and marketing expenses this quarter were RMB10.7 billion, down 16% versus the same quarter of 2021. As we continue to shift away from our previous focus on sales and marketing, we remain disciplined in our sales and marketing spending this quarter. As a result, on a non-GAAP basis, our sales and marketing expenses as a percentage of our revenue this quarter were 45%, compared with 57% for the same quarter in 2021. Our non-GAAP general and administrative expenses were RMB208.8 million versus RMB160.7 million in the same quarter of 2021. Our non-GAAP research and development expenses were RMB2 billion, an increase of 30% from RMB1.7 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. To better meet evolving consumer demand and to boost our sustainable growth on our platform, we are committed to further growing our R&D capabilities and stepping up our R&D spending. Operating profit for the quarter was RMB2.2 billion on a GAAP basis, compared with an operating loss of RMB4.1 billion in the same quarter of 2021. Non-GAAP operating profit was RMB3.7 billion versus the operating loss of RMB3.2 billion in the same quarter of 2021. Net income attributable to ordinary shareholders was RMB2.6 billion, compared with a net loss of RMB2.9 billion in the same quarter of 2021. Basic earnings per ADS was RMB2.06 and diluted earnings per ADS was RMB1.84 versus basic and diluted net loss per ADS of RMB2.33 in the same quarter of 2021. Non-GAAP net income attributable to ordinary shareholders was RMB4.2 billion, compared with a net loss of RMB1.9 billion in the same quarter last year. Non-GAAP diluted earnings per ADS was RMB2.95 versus non-GAAP diluted net loss per ADS of RMB1.52 in the same quarter of 2021. More disciplined spending and slowing growth are the main reasons behind the progress in the past few quarters. The progress gives us more confidence and resources to devote to key areas such as R&D and agricultural initiatives. That said, we expect profits to fluctuate as we spend to meet changing consumer needs. Notably, our profit this quarter narrowed significantly versus last quarter. Our net cash flow used in operating activities was RMB9.1 billion, compared with an outflow of RMB3.7 billion in the same quarter of 2021, primarily due to changes in working capital as a result of seasonality, offset by an increase in online marketing services revenues. As of March 31, 2022, the company had RMB95.2 billion in cash, cash equivalents, and short-term investments. This concludes my prepared remarks.

Chen Penn, Unidentified 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 may take a maximum of two questions per analyst. Lei will answer questions in Chinese and I will help translate Lei’s remarks for ease of reference. Operator, we may now take questions on the line.

Operator, Operator

Ladies and gentlemen, we will now begin the question-and-answer session. Your first question comes from Thomas Chong with Jefferies. Please ask your question.

Thomas Chong, Analyst

Thanks management for taking my questions. My question is about our growth driver in Q1. And given the outbreak of the pandemic in recent months, can management share some thoughts about what we are seeing in terms of the recent monthly trend? On the other hand, can management also comment on the trend in terms of the take rate? Thanks.

Chen Lei, CEO

Hi, Thomas. Let me address your first question around growth rate. Over the past period, we have been going through adjustments in our development strategies to focus more on technology and agriculture in order to pursue long-term high-quality growth. While it takes time for the final results to bear fruit, our growth rate might be affected during this process. In addition, as we reach our current scale, investors should not expect us to continuously deliver high growth. Well, our development is inseparable from the support of our consumers. As our user base reaches its current scale, our focus now is on how to serve our 880 million users and improve their trust and mind share to remain user-centric. We will continue to pay more attention to technology and agricultural investment and to promote our differentiation in agriculture to help create more value for our consumers. As we have been communicating, we always remain committed to investing to create long-term value. If you look from the outside, at times, we might appear to be overly aggressive or overly conservative. So we recommend you not to pay too much attention to the fluctuations between quarters. Instead, we hope investors would focus on whether what we are doing is generating value and whether it can bring about high-quality development. I hope what I've shared may address your question.

Liu Jun, VP of Finance

Well, Thomas, this is Jun. Thank you for your question. I would like to further talk about the take rate just mentioned. Our focus has always been to better serve our users, as Lei just mentioned. With this being said, take rate or monetization rate is not a metric to forecast. Instead, I think it's just a natural result. So, we recommend you not to look at quarter-to-quarter changes; in the long run, our monetization rate depends on how much value we create. For future outlook on monetization, as I said, it really depends on our value creation. One thing we would like to point out is that we started Pinduoduo with a strong agriculture focus from the beginning and we stick to our zero-commission policy for agriculture projects. Hence, we will definitely continue to support agriculture merchants, for example, by offering more traffic exposure. Also, we have communicated before that we will step up investment in agriculture for a better consumer experience. As the proportion of agricultural products increases, our monetization rates might be affected. Thank you.

Chen Penn, Unidentified Company Representative

Operator, we will now take questions from the next analysts in the queue.

Operator, Operator

Your next question comes from Eddy Wang with Morgan Stanley. Please ask your question.

Eddy Wang, Analyst

Thank you for taking my question. I have two questions. First is about competition. Can you please share your view on China's e-commerce industry competitive landscape? We witness that on one hand, we see other e-commerce platforms adopting structured cost control and being less aggressive in expansion. But on the other hand, we see some livestreaming e-commerce platforms being very aggressive in user acquisition and expansion. I just want to hear your view on the competitive landscape in the e-commerce sector and the impact on Pinduoduo? My second question is about the '10 Billion Agriculture Initiatives'. What proportion of the 10 billion has been used so far? What are the areas we want to invest in the next maybe one or two years? Thank you.

Chen Lei, CEO

Eddy, for your question regarding the competition landscape, I think the current landscape has not changed much compared to two or three months ago. Essentially, China's e-commerce industry is a huge market full of potential. As industry infrastructure continues to develop and as consumer needs continue to evolve, more and more companies will join e-commerce. We believe that in the long run, the emergence of new platforms, as well as new formats, will positively impact consumers and the industry itself. If you look at recent changes during the pandemic, we think that for ourselves, there is still a lot of room to improve our current level of service offerings. Our team needs to learn from this and work harder to serve consumers well and create value for society as a whole. This is our responsibility as a company. As for our differentiation, we started Pinduoduo primarily with agriculture products; agriculture has always been our core. We firmly believe in the future potential of the agriculture sector. As I introduced, we are now stepping up investments in core technology, especially agricultural technology. We believe that in the long run, these investments can create more value for consumers. As for your second question, we announced the RMB10 billion agriculture initiative last year. When we announced it, we mentioned that we hope this initiative can facilitate the advancement of agritech, promote digital inclusion, and give a sense of fulfillment for agri workers and agri scientists. Over the past year, our team and I have been diligently evaluating and studying various proposals and projects in order to allocate resources to where they are needed most. In my previous remarks, I've given some examples of how technology empowers agriculture, including our smart agriculture competition. Additionally, we are collaborating with top agronomic universities and research institutions on some research projects. Admittedly, empowering agriculture through technology requires a lot of thinking, deep understanding, and patience. We need to compare various options side-by-side and evaluate each carefully. Our strategy is long-term, and our investment in agriculture is still in its early stages. Given the scale and impact of our investment, our investment horizon and scale would not change due to short- to medium-term fluctuations. I hope this gives you more insight into how we are thinking and what we are doing in terms of agriculture.

Chen Penn, Unidentified Company Representative

Operator, we may now move on to the next analyst.

Operator, Operator

Your next question comes from Kenneth Fong with Credit Suisse. Please ask your question.

Kenneth Fong, Analyst

Thank you management for taking my question. I have two questions, please. On user growth, we noticed that despite a high base, AAC and MAU both see accelerating sequential growth. Can you share with us the drivers behind? I understand that we shouldn't expect fast growth given our larger user base; how should we think about user upside and the ceiling? My second question is on the sales and marketing expense. Despite the fast revenue growth, our control over sales and marketing has been very effective, with the amount continuing to come down on a year-on-year basis. Can you share the reason behind this? For example, is there a change in our ROI threshold on this acquisition, and is there room for further improvement? Last year, Pinduoduo stated that we are shifting from sales and marketing to R&D focus. Can you also update us on the progress? When should we expect this to be largely finished? Thank you.

Chen Lei, CEO

Well, Kenneth. Let me address your question about user numbers. By the first quarter of last year, our annual active buyers and our MAU were approximately 820 million and 720 million, respectively. This was already a relatively high base. By the first quarter of this year, our annual active buyers and MAU further increased to about 880 million and 750 million. We achieved some growth, but the long-term trend should be clear. Though there may be fluctuations, it is inevitable that our user growth will slow. Over the past few quarters, we have shared this view with you. Our priority now is to improve the existing 880 million consumers' user experience and consolidate their trust and mind share in us. Regarding the strategic shift, as we respond to changes in infrastructure upgrade and evolving user needs, our investments in technology seek opportunities to improve ourselves and better serve our users. Through our efforts, we have also created value for consumers, especially in the area of agricultural produce.

Liu Jun, VP of Finance

Okay. Thank you, Kenneth. I will take your second question about SME expenses. As you stated, we are shifting our focus from sales and marketing to R&D, which has been reflected in our financial results. For example, sales and marketing expenses fell 14% year-over-year in Q1, which represented 47% of total revenue, down from 59% in Q1 last year. Meanwhile, R&D expenses increased by 20%. For every investment, we carefully evaluate the ROI and allocate resources to generate long-term and high-quality development. As always, we will continue to maintain our investment discipline. Additionally, we realize that we are not doing well enough in meeting user needs, and there is still a lot of room for improvement. Recent events have highlighted areas where we need to improve. As we identify opportunities, we will continue to invest to create more value for our consumers. Consequently, future expense trends may change. We firmly believe that R&D investment can lead to high-quality development, so we continue to step up investment, which will be reflected in our financial results. We are still in an investment phase rather than a stable phase for financial numbers. We recommend looking at long-term trends and the value we create from this investment.

Chen Lei, CEO

Operator, I think we still have time to take questions from the next analyst, and that will be the last one.

Operator, Operator

Your last question comes from Natalie Wu with Haitong International. Please ask your question.

Natalie Wu, Analyst

Let me quickly translate myself. So, two questions from my side. First question is related to COVID. Can management share more details about how the pandemic has impacted the industry and your operations at Pinduoduo? How much impact has it had on your first quarter results? What is your outlook for the second quarter during the current pandemic status? My second question is regarding profitability. You have delivered new core profit on both GAAP and non-GAAP basis for four consecutive quarters. Are you currently prioritizing profitability over growth? Should investors expect quarterly earnings to be the norm? Thank you.

Liu Jun, VP of Finance

Well, Natalie, let me address your question about how the pandemic has affected us and our operations. One area that the pandemic has shown us is that we need to build our business to be more resilient, and there are certain areas that need further improvement, especially in effectively meeting user needs. Under the current situation, I believe our peers have showcased aspects we may also learn from. Pinduoduo is an e-commerce company focused on essential user needs. During the pandemic, we actively leveraged our differentiation to create value for consumers and fulfill our social responsibilities. For example, in Shanghai, we launched 48-hour supply packages for residents through aggregating their orders and fulfillment staff, striving to meet the basic needs of as many households as possible. Additionally, guided by relevant governmental departments, we provided supplies for medical personnel and those in need. These are areas we have worked on by leveraging our differentiation and value proposition. Another point during this pandemic is the emergence of young talents stepping up to challenges, rapidly growing in the face of real-world issues. They are proactively securing good supply, providing technical support for fulfillment, and solving operational difficulties. They are taking on more responsibilities and challenges, which gives me confidence in our team's potential. Regarding the pandemic's implications on agriculture, the importance of a resilient agricultural supply chain has become clearer. Our long-term investment in agriculture is particularly significant. I hope my thoughts provide more insight into agriculture. Thank you for your second question about profitability. I would like to emphasize that our current priority, and what has driven our profits over the past few quarters, has been due to our operating leverage, especially from sales and marketing. As mentioned last quarter, we have also controlled our spending while facing slower growth. Under current intensified competition, we also recognize our need to improve in serving our users better, as highlighted by recent events. We will need to increase our investments, which may lead to fluctuations in quarterly profit in the future. As seen, this quarter's profit decreased sequentially compared to last quarter. However, the profitability over the past few quarters provides us greater confidence to continue our long-term investments. We hope everyone will focus more on the value we generate.

Chen Penn, Unidentified Company Representative

Okay. Thank you, everyone, for joining us on the conference call today. If you have further questions, please feel free to reach out to our IR team. Thank you. Have a great day.

Operator, Operator

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