Qutoutiao Inc.

Hello ladies and gentlemen, thank you for standing by for the second quarter 2020 earnings conference call for Tu Tao Tiao Incorporated. At this time, all participants are in a listen-only mode. After management's remarks, there will be a question and answer session. Today's conference call is being recorded. I will now turn the call over to your host, Sai-Chi Liu. Please go ahead, Sai-Chi.

Thank you very much. Welcome, everyone, to the second quarter of 2020 Earnings Conference Call of Xutoujiao Inc. The company's financial and operational results were released via Newswire services earlier today and have been made available online. You can also view the earnings press release by visiting the IRR section of our website at irr.xutoujiao.net. Participants on today's call will include our CEO, Mr. Eric Tan, and our CFO, Mr. Xiaolu Zhu. Before we continue, please know that today's discussion will contain forward-looking statements made under the safe harbor provisions of the U.S. Private Security 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 under applicable law. Please note that Chidotel's earnings press release and this conference call include discussions of unaltered GAAP financial measures as well as unaltered non-GAAP financial measures StudioTel'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 the business. So far this year, strategically, we are maintaining a good balance between growth and profitability. In other words, sustainability and healthy growth have been playing a very important role in our thinking. As COVID-19 put a damper on the general economy in the first half, we have taken a relatively cautious approach to managing the overall business. Despite the generally weak market and the slow recovery, for the first half of this year, our business expanded at mid-teens rate in comparison to a year ago in terms of sales. This is the result of all our hard work and unwavering investment. It's a demonstration of the value we create for our advertising customers as well as our loyal users who have been the biggest of support for us during challenging times like this. Our operational efficiency has improved tremendously as we have kept overall costs well under control as the business expands. We managed to operate on a smaller sales and marketing budget while maintaining a larger user base, which has very positively impacted our profitability. At the same time, we invested more into areas we deemed to be strategically important over the long term, mainly technology, algorithms, and content. We have been selective i.e. not as plain and straightforward as just adding headcounts everywhere. Instead, we try to gain a better picture of what we need to drive better growth for the business longer term and prioritize strengthening different segments of our capabilities accordingly. To achieve our long-term objectives, we will continue to focus on content and technology. Since we started to directly sign up writers for medium novels, we have been increasingly seeing this strategy paying off. as their share of the most popular novels keeps increasing, and most recently reached 50%. That has been an important part of our content strategy as we integrate vertically. We will be able to extract much more value from the same IPs. Most recently, our Medium novels also formed a strategic cooperation with Kuaishou in short video series, which will leverage Medium's content and Kuaishou's user traffic. This will raise the profile of middle novels, original content, and create a much stronger basis for the longer-term harvesting of derivative IP value. Coupled with continued improvement in our recommendation engine, we see enhanced monetization efficiency, which has allowed us to drive down user engagement costs while increasing our pool. We feel encouraged by the strategic progress we have been making, especially with respect to content and technology, and we expect them to be the key pillars supporting our future development. Our financial performance is also trending in the right direction, which gives us further confidence that we are taking the right steps. On July the 16th, 2020, China Central Television reported in its annual Consumer Rights Show that certain advertisements placed by third-party advertising agents exaggerated the health benefits of certain food and diet products and promoted activities that may involve online gambling. In response to the issues raised by the report, the company has promptly taken appropriate measures such as immediate suspension of all employees involved in these advertisements, including the person in charge of advertising operations, stricter management of all third-party advertising agents, enhancement of content management capabilities in identifying misleading or inappropriate advertisements, and the launch of an easy-to-use and easy-to-find complaint channel on the home screen of Judo Dial so that users can file their complaints with us about any advertisements placed on our app. The Judo Dial app was temporarily removed from several major Android-based app stores in China after the CCTV report. but was reinstated on July 31, 2020. It is our commitment to bring real value to our users, and it is against our ethos that less than 100% compliant content should appear. The ad industry itself comes with some inherent risks every player has to manage, and which we are also fully aware of. We have always closely followed the rules and regulations of the industry and the country. We aim to build the best content ecosystem for every stakeholder on our platform. We would like to use this incident as a chance for us to further build on the content ecosystem on our advertising platform, which is part of our core strategy to establish a solid foundation for driving long-term growth and strengthening our competitive advantages. We have also taken the time to reflect on the current state of the advertising industry from both a seller and a buyer's perspective. and recalibrate our growth strategy. Going forward, we will de-emphasize growth through spending marketing dollars and drive growth predominantly through engaging content, great recommendations, and an excellent user experience overall. We remain motivated by and committed to our long-term vision of bringing rich and diversified online content to millions of users across the country. We started the business in the first place as we saw the lack of tailored online products and services for people in the low-tier cities, which accounted for the vast majority of China's population. And this gap remains large still as of today and will inevitably be filled as our society moves forward and our organization drives its global income growth. As the first Internet company to dedicate efforts and resources to tackle this problem, we are well positioned to serve a great purpose. and create significant value for all our users in the long run. Thank you very much. That concludes Eric's remarks, and I will now turn the call over to our CFO, Xiaolu.

Thank you, Eric and Caiqi, and again, thank you everyone for joining today's call. Let me first go through the financial highlights of the second quarter of 2020 before touching on financial objectives for the remainder of this year. Our revenues for the second quarter was around $1,441,000,000. which represents an increase of 4% year-on-year and some moderate sequential growth as well. This has been driven by user-based expansion as our DAU has increased by 11% year-on-year, albeit partially offset by the weaker output, which saw a 6% decline, reflecting the difficult advertising market and the generally weaker economy in the second quarter. We have been working hard to improve our operating efficiency and have seen greater results so far this year. Our operational loss ratio has narrowed to just under 10% in the second quarter of 2020, which is a record low, and a significant improvement both year-on-year and sequentially, continuing a very positive trend we have delivered in recent quarters. This has been achieved with much more targeted and efficient marketing spending in terms of both acquiring new users and the user loyalty program. This testifies to the strength of a combination of capabilities in content and technology which we have invested into consistently. Now let's look at costs and expenses in more details. Unless otherwise stated, please note that I will be referring to non-GAAP measures, which means share-based compensation is excluded. Cost of revenues were RMB 397 million in the second quarter, an increase of 10.4% from a year ago, primarily attributable to increases in content-related costs. reflecting the company's long-term vision to build a platform delivering high-quality online content to our users. Gross profit was RMB $1.44 billion in the second quarter, an increase of 1.7% from a year ago. Gross margin was 72.4% compared to 74% in the second quarter of 2019. The decrease of gross margin year-over-year was mainly driven by the growth of content-related costs. R&D expenses were RMB 195 million in the second quarter, an increase of 6.1% from a year ago. Sales and marketing expenses were RMB 922 million, a decrease of 29.6% year-over-year. Sales and marketing expenses as a percentage of net revenues was 64% in the second quarter of 2020, compared to 94.5% a year ago, continuing to hit record low. User engagement expenses were RMB 457 million in the second quarter, a slight increase of 1.7% year-over-year, and a decrease of 9.9% quarter-over-quarter. User engagement expenses per DAU per day were RMB 12 cents in the second quarter of 2020 and compared to RMB 13 cents in the second quarter of 2019. The decrease of user engagement expenses year-over-year was primarily due to the company's ongoing efforts in optimizing user engagement expenses for its loyalty program, as well as enhanced personalized reading experience facilitated by our AI platform and our enriched content library. User acquisition expenses were RMB $436 million in the second quarter, a decrease of 44.7% year-over-year and 13.2% quarter-over-quarter. User acquisition expenses consist of the cost of both referrals and third-party marketing, The decrease mainly reflected the company's efforts in optimizing its traffic acquisition strategy and, to a lesser extent, the weak advertising market environment in the first half of this year. G&A expenses were RMB 92 million in the second quarter. Non-GAAP loss from operations was RMB 148.6 million in the second quarter of 2020, compared to RMB 506 million a year ago. Non-GAAP operating loss margin was 9.8% compared to 36.5% in the second quarter a year ago, an improvement of over 26%. Non-GAAP net loss was RMB 173.3 million compared to net loss of RMB 496.3 million in the second quarter of 2019. And the non-GAAP net loss margin was 12% compared to 35.8% in the second quarter of 2019. Now onto the outlooks for Q3 and the second half of 2020. The CCTV report, which Eric referred to earlier, caused the tutorial application to be taken off app stores for a short period of time in earlier Q3. The company has observed negative impacts on its business operation and financial performance due to this in this quarter and is still evaluating the extent of such impacts. QTOTL highly appreciates the importance of strict compliance with all applicable laws and regulations and believes the measures taken by the company are critical to protect the interests of its users and investors in the long term. For the third quarter of 2020, the company currently expects net revenues to be between RMB $1.13 billion to RMB $1.15 billion. This outlook reflects TrudeauTel's current and preliminary view, including preliminary assessment on the potential impact from the CCTV report, which is subject to uncertainty. In terms of the bottom line, we expect our operating loss to be narrow significantly on a year-over-year basis and flat on a quarter-to-quarter basis in the third quarter. And we remain committed to further improve our operational efficiency as we have achieved consistently over the past several quarters, and we expect this trend to continue in the fourth quarter of 2020 and beyond. This concludes today's prepared remarks. Again, thank you all very much, and we are now open for questions. Operator, please proceed.