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spk01: 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.
spk04: 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.
spk05: 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.
spk01: Thank you. We will now begin the question and answer session. If you wish to ask a question, please press star 1 on your telephone keypad and wait for your name to be announced. If you wish to cancel the request, please press the pound or hash key. Once again, please press star 1 if you wish to ask a question. The first question comes from the line of Zoe Deng of KeyBank Capital. Please ask your question.
spk03: Thank you, Management, for taking my question. I'm asking the questions on behalf of Hans Chan. So I have two questions. My first question is about the third quarter guidance. So the third quarter guidance is much lower than the consensus because of the CCTV report issue. But even when we add back the two weeks run rate due to the temporary removal of True Hotel app from Android app stores, third quarter guided revenue is still well below consensus. So could you elaborate on the... Does ARPU get impacted because we clean out those non-compliant ads? And my second question is, although the third quarter revenue is guided down quite a bit from the second quarter, operating loss is still expected to be flat sequentially. So where are we cutting the most in expenses? Thank you.
spk05: Thank you, Zoe. These are very important questions. Regarding our first question on Q3 guidance, I think as we have said in the prepared remarks, both us and our advertising partners are quite cautious post the CCTV report. And we took extraordinary measures to make sure that our content and ads are compliant. I would say that we went above and beyond what the laws and regulations as well as industry practice would normally require in China. And the second reason, and I believe more important reason, as we have said repeatedly in previous earnings calls, is that we want to take a more balanced approach between profitability and growth. So this means three things. First is that because we took and will continue to take a more disciplined approach towards investment, especially on the marketing side, and we would require a good ROI for every marketing dollar we spend. So we are likely to see a more subdued growth trend in terms of both revenue increase and user-based expansion in the near term, rather than the net breaking speed we have experienced back in 2018. Second, we want to make sure that we get to a break-even of some profitability by the end of this year. And this is the key priority for us. And we will continue to see top-line growth going into Q4 and beyond. But the more important target for us right now is to get a positive bottom line. And last but not least, we want to further shift the user base mix towards users that are attracted to our platform by content, be it news feeds, short videos, or novels, etc. We want our royalty program to stimulate and encourage our users to stay engaged with us, but we don't want them to be on our platform purely for the royalty points. So as we have said before, we believe content and recommendation algorithms are the key pillars for our future growth. and the user base build out of these would be a good foundation for our long-term sustained growth. So regarding your second question, our pool and breakeven, I think we still target to be breakeven in Q4 on a non-gap operating basis. We are already very close to break even in June, and despite the recent setbacks, we expect operating loss in Q3 to be in line with Q2 and to improve significantly compared to the same period one year ago. So given the recent trend, the recovery of our revenues as well as the usual seasonality, which means that Q4 usually will be the best season for advertising of the year, we are very confident that we will continue to improve our operating efficiency in the rest of the year and to get to brick-even in Q4. And if you look at the major line items, I think first that we will continue to invest in content and technology, which we believe is vital to our long-term success, and we'll keep a similar level of investment in absolute dollar terms for content and technology. Total sales and marketing expense was at 64% of our revenue in Q2, over 30% improvement year-on-year, and we believe this trend will continue and we'll definitely see further operating leverage from this end for the common quarters. And especially savings from user engagement expenses with better algorithms and better content as we have explained in the prepared remarks. So, our user engagement expands at 12 cents per user per day and only about half the level from the peak two years ago, and we plan to keep that figure at a similar level or even lower for the coming quarter. And in terms of PEC, we have been very conservative so far this year, and we probably will continue this approach as well. If you look at our bottom line, non-GAAP operating loss margin for Q2 was less than 10%. As we have said in our Q1 earnings call, we see at least 10 percentage point improvement in Q2 compared to Q1, and the actual improvement was over 15%. So in all, we are still very confident to get non-GAAP re-given by Q4. And along the way, we will also have a better user mix with more users attracted to our platform by our content. Thank you.
spk01: Our next question comes from the line of Vicky Wei of Citi. Please ask your question.
spk02: Thank you, management, for taking my questions. So you shared a bit about the break-even target for the second half. So may I ask what is the company's strategy to maintain user growth and reduce costs to achieve profitability? So would you please elaborate about the user growth strategy while you prioritize the profitability. And my second question is what does management think of the second half advertising market sentiment? And what do you think how long the CCTV impact will last? Thank you.
spk05: Thank you, Vicky. So for your first question regarding user growth, I think as we have, you know, explained before that we do want to make sure that we will continue to have, you know, long-term sustainable growth and we want to take an approach, you know, balanced between profitability and growth. But obviously we want to be, you know, profitable at the DAO level of over 100 million rather than the current 40 plus million. But however, we do want to make sure that we are on the right path for long-term growth and also want to prove the value of our users and our business model. And we think to achieve profitability this year is the right choice given the uncertainty in the market. But as I said, we still plan for healthy user-based expansion and revenue growth for the coming years. The other thing to note is that this is the result of a more disciplined spending instead of simply cutting the budget, which means that we are getting the results we want with good ROIs for each marking dollars we are spending. And if the market recovery continues and if the ROI is right, which we believe it will, then we will not hesitate to invest for the future. The other thing that we have already said that we do want to have a better user mix. users that are attracted to our platform by content, be it news feed, short videos, or novels, and et cetera. We want our loyalty program to encourage our users to stay, to engage with us, but we don't want them to be on our platform purely for the right points. So we do want to make sure that along the way, in our path towards profitability, we will get a better user base mix, This will be a good foundation for our long-term growth. Regarding your second question on the overall market, I think that we have seen the market start to pick up in the second half of Q2, and this trend continued in Q3. So it's still not back to the levels we have seen before the pandemic, but the overall trend in the market looks promising. As we have said in the prepared remarks, the CCTV report caused the Q2 application to be taken off app stores for about two weeks. We have observed negative impacts on our business operation and financial performance due to this in Q3, and we are still evaluating the extent of such impacts. But as we have said, we have already seen a trend of recovery, and we think that the growth and recovery will continue in Q4. Thank you.
spk02: Thank you.
spk01: Your next question comes from the line of Thomas Chong of Jefferies. Please ask your question.
spk00: Hi, management. Thank you for taking my question. I'm asking on behalf of Thomas Chong. My first question is about the content cost trend. Acuity is committed to deliver high quality content to users and this will continue to be our goal to drive the user engagement. Should we expect to see a continual increase in content cost? And could you also share on the revenue sharing trend with the content creator? And my second question is on the GDP margin. So after talking about the cost content trend, how should we see its impact on the GDP margin? And we see the GDP margin increase quarter over quarter in the second quarter. So, should we continue to expect there will be a margin expansion? Thank you.
spk05: Thank you. So, regarding your first question, in terms of content cost trend, yes, we have made significant investment on the content side, especially for MeDo for the last few quarters or for the last one or two years. And in terms of revenue sharing, I think as we have explained before, because there are lots of freelancers and other content contributors to our newsfeed business, I think the content sharing for the newsfeed side of the business will continue to be quite low, less than 10%. On the MEDU side, we usually share about 20% of our revenue with our content providers. But as we start to grow this business and as we make more investment and sign more contracts with different content providers, there will be different contractual arrangements here and there. So there might be some fluctuation, especially on the MEDU side in terms of content cost. from quarter to quarter, but I think overall the trend will continue to be stable. So, content cost as a percentage of revenue I think probably will, you know, fluctuate from quarter to quarter but remain at a similar level over the longer term. So, in terms of GP margin, it's basically the same question because, you know, the main impact factor affecting our GP margin over the last few quarters are the content cost, and so if we increase our content cost a bit from quarter to quarter, there might be some fluctuation to our GP margins. But I think overall, I think we'll continue to see a GP margin around 70 percent or some quarters over 70 percent. Thank you.
spk01: Thank you. Once again, if you wish to ask a question, you may press star one on your telephone keypad. Again, it is star one if you wish to ask a question. If there are no further questions now, I'd like to turn the call back over to Saichi.
spk04: Thank you all very much for joining us for today's call and if you have any further questions, please don't hesitate to contact us at the Investor Relations Department. Thank you all and have a good day.
spk01: Thank you. Ladies and gentlemen, this concludes today's conference call. You may now disconnect your line. Thank you.
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