Qutoutiao Inc  (NASDAQ: QTT) Q4 2019 Earnings Call Transcript

Qutoutiao Inc  (NASDAQ: QTT) Q4 2019 Earnings Conference Call

March 18, 2020

Corporate participants:

Ethan John —

Xiaolu Zhu — Chief Financial Officer

Analysts:

Zhijing Liu — UBS — Analyst

Nelson Cheung — Citi — Analyst

Unidentified Participant — — Analyst

Jay Dong — TH Data Capital — Analyst

Presentation:

Operator

Hello, ladies and gentlemen. Thank you for standing by for the Fourth Year — Quarter 2019 Earnings Conference Call for Qutoutiao Incorporated. [Operator Instructions]. After the management’s remarks, there will be a question-and-answer session. [Operator Instructions].

I will now turn the call over to your host, Ethan John [Phonetic]. Please go ahead, Ethan.

Ethan John —

Thank you very much. Welcome everyone, to the fourth quarter of 2019 earnings conference call of Qutoutiao, Inc. The Company’s financial and operational results were released earlier today and have been made available online. You can also view the earnings release by visiting the IR Section of our website at ir.qutoutiao.net. Participants on today’s call will include our CEO, Mr. Eric Tan; and our CFO, Mr. Xiaolu Zhu.

Before we continue, please note that today’s discussion will contain forward-looking statements made under the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, the Company’s results may be materially different from the views expressed today. Further information regarding these and other risks and uncertainties is included in the Company’s prospectus and other public filings as filed with the U.S. Securities and Exchange Commission.

The Company does not assume any obligation to update any forward-looking statements, except as required by applicable law. Please note that Qutoutiao’s earnings press release and this conference call include discussions of unaudited GAAP financial measures as well as unaudited non-GAAP financial measures. Qutoutiao’s press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited GAAP measures.

I will start by reading out Eric’s commentary on business. I would like to start with a performance review for the last quarter of 2019 before discussing the longer term initiatives and investments we have been undertaking, for building and prospering franchise for the future. I will also touch on the impact of COVID-19 before providing an outlook for the business.

Last year was a year of challenge for everyone in the industry. Oversupply in the market, coupled with moderating economy, put significant downward pressure on the pricing environment. While irrational competitions helped our cost lines. Adding on top was also a tightened up regulatory environment, which called for adjustments for business involved in every Internet content category.

These factors combined made a challenged economic test for all and resulted in a bifurcation as a result of the differing underlying strengths of individual players. It was again such a challenging backdrop that we managed to double our average DAUs for the whole of 2019 year-on-year and drive a similar level of growth in total revenues, materially outperforming the wide market.

In the fourth quarter, our revenues grew by 25% year-on-year, despite market headwinds and the negative impact of Midu suspension, which mostly hurt the third quarter of 2019, but lasted into the first half of the first — fourth quarter. The gradual recovery from the suspension was partly by choice as we had taken the low as an opportunity to revamp product design and upgrade content, while recalibrating the long-term strategy. Driving the growth was not just expanded due to growth, due to the base, but also crucially an enhanced monetization engine, as we have observed better added conversion metrics, which are structural in nature.

The sequential improvement in ARPU was also reflective of the enhanced monetization efficiency. Most of our adverts are performance based which are better positioned as a sub-sector, than the traditional brand-based or impression-based segments. From an advert buyer’s perspective, the advantage of the measurability of budget ROI in performance ads is becoming more pronounced especially in a weak market.

And I believe the budget allocation shift towards performance ads will be a long-term trend. During the fourth quarter, our new business lines such as leisure games and livestreaming were also showing promising early results with user base expanded to reach levels that gives us confidence that our revenue diversification initiatives will add meaningful upside to our monetization potential over time.

Well, we have taken a more stringent approach towards Financial Planning and Management. Our focus on investing into the business remains as intensive as ever. We have made meaningful progress on three fronts. The algorithms that drive feed recommendation, our OCPC system and proprietary content ecosystem for Midu.

To drive the continuous upgrade of algorithm, we have established a first-class proprietary machine learning platform which is crucial in facilitating the faster training of algorithm that will lead to better feed recommendation based on machine analysis and understanding of the user preferences.

Our platform would allow the processing of a huge expanded data pool with much quicker turnaround, while also reducing unit processing costs through cooperation with leading service providers, such as AliCloud. This demonstrates our long-term commitment to R&D efforts, in better algorithms and better content distribution and recommendation mechanisms. In order to feeding to the platform large quantities of valuable data real time, we have sorted through all user behavior data across all our product lines, pooled them together and have them organized in a much more intelligent way, with more precise characterization of each behavior scenario totaling in that experience.

Since we initiated the transition into an OCPC system, a year ago, we have quickly covered 90% of customers spending on our platform with first-degree OCPC realization, which optimize the cost per action for customers. We have also covered 30% of customer spending with second-degree OCPC realization, which further takes responsibility of optimization user behaviors, post CPA, i.e. key user quality metrics such as retention rates, paying ratios, time spend, etc.

The extent to which customers are willing to allocate budget toward our OCPC offerings especially towards the second degree realization demonstrate how much they recognize and value the productivity of our OCPC system. On this measure, we are among the leaders of the industry and we have achieved such a position within a shorter period of time in comparison to peers.

As we have discussed before, the ongoing structural trend of advertising budget shifting towards performance based ads will see us as a clear beneficiary and further strengthen our competitive position in the market. In terms of content investment for Midu, we continue to expand the scope of our strategic collaboration with the major copyright owners after initiating a deep strategic relationship with iReader, in the third quarter of 2019.

The size of our book reserves grew by approximately 30% during the fourth quarter of 2019 with the smaller categories driving most of the growth, which suggest a diversification of the kind of titles [Phonetic] we can offer to our loyal readers.

Since we started building our proprietary content ecosystem by working with up and coming authors directly, we have proven our original leases right, i.e., the power of algorithm in discovering talent and guiding high quality content production. About 20% of our most popular books are now developed in-house to which we own the copyright.

The significance of this achievement is two-fold. First of all, our data assisted literature development process is very effective and efficient. Secondly, given our user demographics is highly representative of the overall population, therefore our data can give us a better understanding of the entire underlying market.

We are in a good position to explore the downstream potential of user copy — of our copy rights, which opens up to a significant long-term upside in terms of monetization. Let me finish by providing you with some outlook for the business. The outbreak of COVID-19 across the globe has put pressure on the overall advertising market in the near-term as advertising budget in general could be constrained. Although performance ads given the measureability of their effectiveness could feel relatively better, the longer term impact on the Chinese economy and the advertising industry remains to be seen.

It will depend on how quickly the situation is brought under control, both here in China and around the world, which we’ll closely monitor. We will continue to improve the monetization efficiency of our advertising platform, driven by continued investment into people and R&D infrastructure. This is a gradual process which involves lots of hard work, patience, and resources. But we believe this is at the very heart of the strength and the durability of the business we are building as it is what completes and induces the virtuous cycle driving the economics of the business model.

We also like to keep expanding into new categories of adverts, so that we can better leverage our increased knowledge and understanding of our user’s profiles [Phonetic] as a result of our enhanced algorithm. We keep an eye on potential new business opportunities as well, whether they be new products, new features to existing products on new monetization avenues as we try to stay nimble and innovative.

Last, but not least, we will maintain a balance between growth and profitability as we move forward, focus on long-term investment into building our — into building out our overall technology capabilities at all levels, and in all aspects, which is core to our fundamental identity. Thank you very much.

That concludes Eric’s remarks and our CFO, Xiaolu will now read his own remarks.

Xiaolu Zhu — Chief Financial Officer

Thank you, Ethan, and Eric and thanks to everyone for attending our earnings conference today. So first of all, let me go through our financial highlights of the fourth quarter 2019 with you. Our revenues grew by 25% year-on-year during the quarter to reach RMB1,660 million, which is also a 18% sequential improvement from the third quarter of 2019.

The growth has been driven by enhanced monetization efficiency and the user base expansion with DAU averaging over RMB45 million during the quarter, representing a 48% increase year-on-year. Our ARPU, which is defined as revenue per DAU per day was RMB0.39 in Q4’19 compared to RMB0.36 in Q3 2019 and RMB0.47 in Q4 2018.

The year-on-year decline reflects the general weakness of the advertising market this year, as well as the recovery of Midu taking a gradual path especially in the first half of the quarter. The sequential improvement was mostly attributable to improvement in monetization efficiency as well as Midu increasingly contributing more revenues. We have made more strategic budget allocations which de-emphasis short term user and revenue growth and instead focus on investing into R&D and building a higher quality and more diversified content ecosystem to maximize our long-term potential.

Now moving into line items of the P&L. Please note that the following discussions of costs and expenses will focus on non-GAAP measures, which exclude stock-based compensation. Our gross margin was around 70% in Q4 2019, a sequential improvement of 5 percentage points from Q3 2019. Reflecting the improved monetization, it decreased from the level one year ago, which stood at 85% due to the impact of Midu revenue loss, lasting into the first half of Q4 2019, as well as increased investment in content, infrastructure and the negative revenue mix impact.

We are spending almost three times as much on content versus a year ago, partly because of the user base doubling and partly because of the deeper collaborative relationships we established with top content producers on the online literature side, which involved some front end loaded expenditures, temporarily inflating cost ratios somewhat. Over time what we’ve gained in competitive advantage as a result of this will far outweigh the cost.

And we have discussed during our last earnings call, we believe the gross margin of our business will gradually recover in Q4 2019 and beyond, after the slump in Q3 last year. Our R&D expenses have increased by 106% [Phonetic] year-on-year, outpacing revenue growth, resulting in R&D expenses as a percentage of revenue, increasing from 9% in Q4 2018 to 14% in Q4 2019. This reflects our commitment to driving the business towards strong core technological capabilities. With healthy revenue growth obtained and good cost control overall, our sales and marketing expenses as a percentage of revenue came down to 82% in Q4 2019, which represented a significant improvement of more than 20 percentage points, both year-on-year and sequentially.

Our general and administrative expenses was 3% of the revenue, in line with history. Therefore, despite the materially increasing investment in key focus areas like R&D and content, our margins have trended well, with non-GAAP operating loss ratio at 28% in Q4 2019 significantly improved from the 59% for the quarter before. As of December 31st 2019, the Company has cash, cash equivalents, restricted cash and short-term investment of RMB1,650 million or $237 million in US dollars.

Now I would like to talk a bit more about our main financial objectives this year, which is to breakeven our non-GAAP quarterly basis in the second half of this year. We have three levers to pull. First, we expect monetization efficiency to further improve, as our ongoing R&D efforts and investments bear fruit. Upgraded algorithms and OCPC offerings, which as Eric mentioned are some of the key step-ups we achieved, which will enable us to increase the sophistication and the value-add of our service to our advertising customers.

Aided by deeper understanding of our users and the availability of richer advertising content formats, through our various different product offerings. Second, we continue to explore new monetization channels such as live streaming which is more than just incremental revenue generation from existing traffic. From a user’s perspective, this is an additional functionality of application, which makes the application more useful and engaging, leading to better user retention over time.

We draw support from our current data. From a commercialization perspective, this step is also crucial in nurturing the paying habit of our users, because previously our users pays nothing upfront, for our products and services, but with live streaming which naturally generates monetary donations, the users will over time become comfortable with the idea of spending money directly on our platform, which would open the door for us to push harder for monetization strategies outside of advertising, such as e-commerce and the membership for Midu.

Third, on the back of better monetization efficiency, we expect the trend of improving margins to continue in 2020, benefiting from economies of scale as we optimize our cost structure and the management team here is committed to use our capital wisely with a disciplined approach. Looking ahead, we expect a low key 2020 as COVID-19 has introduced a lot of uncertainty into the economic outlook, and put a lot of pressures on the advertising industry in China.

However, we remain focused on our key strategic objectives as we continue to see relative strengths in demand for performance based ads. We are also actively looking at further expanding the range of sectors, our advertising customers are in. To increase exposure to currently under-represented areas such as insurance, second tier e-commerce platforms and also heavy gains. If we keep our eyes on our long-term vision and do a good job with what we can control, namely keep improving the monetization efficiency of our platform, explore new revenue opportunities and synergies and beat discipline of our costs, we will weather the storm and emerge from it as an even stronger business.

We see the business continue to grow for the first quarter of 2020. We now expect net revenues for the first quarter to be between RMB1,400 million to RMB1,420 million. The midpoint of which represents an increase of 26% year-over-year. This has already taken into account, the impact of COVID-19 in Q1 so far. Assuming no material further deterioration with the pandemic situation, especially domestically, which currently seems to be the most likely outcome, we shall wait until later in the year for our full year outlook given the fluid nature of the current situation and we’ll update you accordingly.

But overall, we remain confident that our financial goal of even on a non-GAAP quarterly basis in the second half of this year can be achieved as we take advantage of the inherent operational leverage in the business. That concludes our prepared remarks today. Now we are open for questions. Operator, please proceed.

Questions and Answers:

Operator

Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions]. Your first question comes from the line of Zhijing Liu from UBS. Your line is now open, Zhijing.

Zhijing Liu — UBS — Analyst

[Foreign Speech]. Let me translate myself. Thank you, management for taking my questions. I have two questions. What’s your plan for free reading app Midu in 2020? Has it already encountered some bottleneck or we still see great upside for this app? Secondly, R&D expense had a surge of over two-folds in 2019, will that stabilize in 2020? Thank you.

Xiaolu Zhu — Chief Financial Officer

Okay, thank you, Zhijing. So as we have said in our prepared remarks, our focus this year will be on to find a base for long-term sustainable growth for the entire Company, that includes Midu. However, we do see a great upside in this business, especially over the long term. But given this year’s uncertainty in the market, we want to be smart with investment and with our capital at hand. So together with the entire Company, we will be focusing more on achieving long-term growth and the key focus area for Midu this year will be on the content side and also on the user experience side at least for the first half and we believe the content and the user experience will be the key differentiator down the road.

But regardless, we see a great potential for Midu and it has achieved a great operating results, especially in the second half of Q4, and we see this trend to continue and we don’t see any reasons for it to slow down. But as I said, we will take a disciplined approach towards investment, especially under these uncertain times. So for — especially for Q1 and the first half of this year, we as a Company, don’t have any specific DAU goals for our products, but we do expect some growth in terms of both DAU and revenue for all our product lines.

By the way, as I said, we don’t have any aggressive plans in terms of pushing DAUs while the overall market is under pressure. So to your second question regarding R&D expenditures, yes, we have made heavy investment in R&D in 2019 and this investment will continue. But as most of our investment are in talents and top-tiered engineers that we have recruited in 2019, we don’t see any big increase from that part in 2020. And I think we have already build a top tier team here at Qutoutiao and we are very happy to see their progress so far.

And we don’t have any plans to further increase the size of the team or further increase our R&D expenditures this year. Thank you.

Operator

Thank you. Your next question comes from the line of Alicia Yap from Citigroup. Your line is now open. Alicia?

Nelson Cheung — Citi — Analyst

Hi, management. Thank you for taking my question. This is Nelson Cheung asking on behalf of Alicia. I have two questions, specifically on — for the first quarter. Given the solid revenue guidance in the first quarter can management elaborate more on the main drivers behind the growth? Which advertising centers is going to see more resilient traction while which center is mostly impacted by coronavirus outbreak?

Also can management remind us about the current effort — the current advertising mix as well, it would be great. And my second question is regarding the margins. So in light of coronavirus outbreak, has Qutoutiao spent more aggressively on user acquisition or engagement and what would — what will be the implications of margin for the first quarter and for the entire year? Thank you.

Xiaolu Zhu — Chief Financial Officer

Thank you. So, regarding your first question, the revenue growth for Q1 under the COVID-19 impact, I think you know as you can see in the market, everyone is taking a more cautious approach toward marketing spending and overall ad budget under these uncertain times that include us. And we expect the overall advertising market to remain weak for the near future.

However, as we have said in the prepared remarks, we are also riding on the trend where customers are allocating more and more budget to performance-based ads, because this type of advertising offer superior, instant and highly measurable results. And increasingly our customers are using performance based ads as their sales channel rather than marketing channel, which means they will have a bigger budget if they want to continue to increase their business.

So as long as we can offer superior ROIs for our customers’ investment, the natural result would be increased budget on Qutoutiao. So we have seen a healthy trend in terms of revenue growth and better monetization efficiency starting from the later half of Q4 2019 and this trend continued in Q1, before the coronavirus outbreak. And as you can see, the midpoint of our guidance represents a 26% year-over-year revenue growth, which is slightly faster than the growth rate we achieved in Q4 ’19, which means we have seen a trend of re-accelerating the revenue growth, despite the impact from the coronavirus.

So should the situation do not deteriorate further, at least in China, we see a good chance that we can keep this rate of revenue growth for the rest of the year, if not faster. And in terms of sectors, I think overall we see the impact is across the board. Everyone is being cautious to different extent. But so far as I said, we are still trying to keep up with what we can control, which means that increasing the monetization efficiency for us and for our customers and also expand into new categories, finding new channels for monetization like live streaming and video games. That’s our approach toward this outbreak.

For your second question regarding our margins and the TAC for Q1 as we have said, that we want to take a disciplined approach towards costs and expenses, and also we want to be smart with the capital we have at hand, especially in 2020. And for this quarter, we see a continued improvement in terms of non-GAAP net loss margin compared to Q4, I think for both in terms of absolute dollar amounts or as a percentage of revenue and which means that we probably will be control all different costs and expense lines, especially on the traffic acquisition side. Given the weakness of the end market, so far, and we do want to keep stringent ROI requirements for new user acquisitions, so which means that we will see better efficiency, better returns of our investments, but probably a smaller budget, at least for Q1 and the near future. Thank you.

Nelson Cheung — Citi — Analyst

Thank you.

Operator

[Operator Instructions]. Your next question comes from the line of Thomas Chong from Jefferies. Your line is now open, Thomas.

Unidentified Participant — — Analyst

Thank you management for taking the questions. I’m asking the question on behalf of Thomas Chong. First of all, I would like to ask about — can management share the color on the MAU and DAU trend since management said that we don’t have a specific target for that, could you share more on the trend? And secondly, we would like to ask about the competitive landscape in the online reading Midu, with the China Literature. Thank you.

Xiaolu Zhu — Chief Financial Officer

Thank you. So, regarding your first question, the DAU and MAU trend, I think as you can see, we have seen very nice growth trend in Q4 in terms of both MAU and DAU and also for the entire year of 2019 despite the regulatory impact on Midu in the middle of the year. However, as I said, our focus this year will be on long-term sustainable growth for the Company, and given the current pandemic situation, we want to be clever with our capital and be disciplined with cost and expenses.

So for Q1, I think we have — we will continue our stringent ROI requirements for our marketing dollars which we started from Q4 last year and we will continue to do so this year. This means we will — we will see better returns for our investment in acquiring new users, but likely a smaller user acquisition budget for the year, both in absolute dollar terms and as a percentage of revenue.

And for Q1, we think that the DAUs will very likely to remain at a similar level as Q4 last year, and right now we don’t have any specific DAU targets for the whole year, however, given the year-on-year revenue growth we have achieved so far in Q1, I think we should be able to ramp up our TAC a bit in the coming quarters, if the macro situation can stabilize in China.

But as I said before, this is still a fluid situation and we will monitor this closely. In terms of competition on the Midu side, we see no significant changes in the industry landscape in Q4. There are some newcomers like ByteDance, and also we have seen that Baidu made several investment in this area. But we view this as a positive sign for the entire free literature market as this demonstrates people’s conviction in the market and the business model.

We, in terms of our competitive advantage, I think we still command the most comprehensive content library in the free reading market and we have good relationship with most of the major content providers and we have made a conscious effort in promoting our in-house productions starting from the second half of last year. And now as we have said in our prepared remarks, 20% of our most read books are already in-house productions.

Our user profile is more similar to the general population distribution in China and we have more users in the third and fourth-tier cities. So we — we believe that we have a better understanding of the user preference of the larger underlying market, which gives us an edge in determining what kind of content to promote or recommend to our users. And we also offer real time feedback to our writers, in all, so we view this as a very promising market and we are starting to view some of the competitive edge that we believe will be key down the road. Thank you.

Operator

Thank you. Your next question comes from the line of Jay Dong of TH Capital, your line is now open. Jay?

Jay Dong — TH Data Capital — Analyst

Yeah, thanks for taking my questions, and my question is about live and short video. And can management share more color about live and short videos certainly [Phonetic] in 2020?

Xiaolu Zhu — Chief Financial Officer

Okay. Sure. So videos and short videos are two key focus areas for us, not only for this year, but also we have already spent a lot of effort and investment in 2019. So videos published on Qutoutiao, the newsfeed app increased 188% in Q4 2019 compared to the same quarter a year ago. And our stand-alone short video apps reached a combined DAU of 4 million in Q4 last year, and average PV was 320 million in Q4 with total time spend increased ten-fold year-on-year.

So today, it’s still a small business compared to the users we have on Qutoutiao or Midu, but we see very promising signs and we will continue to invest in this area in 2020. And also the other, the other aspect we have discussed is that we see increased user engagement and activeness as a result of us offering more different content formats, and also the short video is a very good format for advertising. And we have seen strong contribution to our revenue growth from short video apps in Q4 2019, and this quarter already, and we believe this will continue in 2019. Thank you.

Operator

[Operator Instructions]. As there are no further questions, now I’d like to turn the call back over to the Company for closing remarks.

Xiaolu Zhu — Chief Financial Officer

Okay, thanks. This concludes our conference call today. Thank you for joining us. We will see you next quarter. Thanks. Bye.

Ethan John —

Thank you.

Operator

[Operator Closing Remarks].