Logo of jester cap with thought bubble with words 'Fool Transcripts' below it

Image source: The Motley Fool.

Qutoutiao Inc. (NASDAQ:QTT)
Q2 2019 Earnings Call
Sept. 4, 2019, 9:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Hello, ladies and gentlemen. Thank you for standing by for the Second Quarter 2019 Earnings Conference Call for Qutoutiao Inc. 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 and I will now turn the call over to your host, Sai Chi [ph]. Please go ahead, Sai Chi.

Sai Chi -- Qutoutiao Inc.

Thank you very much. Welcome, everyone, to the second quarter of 2019 earnings conference call of Qutoutiao 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 IR section of our website at ir.qutoutiao.net. Participants on today's call will include our Co-Founder and CEO, Mr. Eric Tan, and our Co-CFOs, Mr. Jingbo Wang and 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 and 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 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.

Now, let me start by reading out Eric's commentary on the business first.

Eric Tan -- Chairman and Chief Executive Officer

[Through translator] I would like to review the business and our strategy with you first and then provide some outlook for the rest of the year. In the second quarter, we have focused on three things. The first is growth. The overall business continues to enjoy strong momentum, with quarterly average combined DAU reaching 38.7 million and combined MAU reaching 119.3 million, both more than tripled from a year ago.

In addition to scaling up existing apps, we have leveraged our platform capabilities to develop new products. In May, we started Midu Light, which is a mobile application that allows users to read online literature for free while earning loyalty points. The valuation and design helps us to attract a user base that is different from that of the Midu app and is, therefore, a valuable addition to our family of apps.

The second is compliance. As we all know, compliance requirements for internet content have tightened up considerably this year. We have one of the best track records in compliance among all the sizable newsfeed players in the space, as we have put in significant efforts from the very beginning in building our content compliance teams and capabilities. Last month, we expanded our compliance personnel by adding a team based in Xinjiang, which will strengthen our content review and monitoring. We have recently been granted an internet news license, which is the first for a non-state-owned company since 2017 and the first and only one in Shanghai, representing an official recognition of our effort in content quality and compliance as well as our leading market position.

The third is the optimization of internal teams to support future growth. Our shift to build a service-oriented architecture by modularizing common functionalities and building full-function teams is progressing well. It's a significant step toward our long-term positioning as a multi-product platform. In this quarter, we started a rotational program for our team leaders, which offered them opportunities to be fully involved operationally in various parts of the business. This gives our key management staff a more comprehensive operational experience with the business, which will enhance efficiency and internal collaboration. We believe such organizational changes will pay off over time and strengthen our long-term competitive advantage, especially as our business continues to scale up.

Let me also talk about our competition in the market. With the Qutoutiao app, by focusing on regions outside of Tier 1 and Tier 2 cities in China and pioneering the loyalty program, it has differentiated itself from competitors and captured a large underserved market. The relative lack of technology infrastructure and services have caused low-tier cities to digitally fall behind the Tier 1 and Tier 2 cities. By contributing to the narrowing of this digital gap, Qutoutiao is playing a positive role in social development, which we believe is both a great cause in itself and a great structural theme to play into. We have built a deep understanding of the people we serve, which has underpinned our leadership position in the market.

Midu started in a competitive online literature market where strong and dominant players already existed. Pioneering the free-to-read model, Midu expanded the addressable market by offering a solution to hundreds of millions of online literature lovers who had been previously excluded by the traditional paid-only business models. Midu has maintained a leading position in the free-to-read market since inception and already has the rigid content ecosystem by a clear margin in comparison to direct peers.

We have also built an internal editor team to work with writers directly to introduce original and differentiated content, which has grown exponentially in page view share, albeit from a very low base. The value of our efforts in enhancing content offerings will not be visible in the immediate quarter or quarters but will, over time, lead to better user retention and engagement, which is key to our user base expansion.

For mid-July, we have temporarily suspended content updates and commercial activities on Midu as we sort through our existing library to adjust to the regulators' compliance requirements. This also puts a temporary break on our DAU as we are not able to acquire any new users through regular channels during the period. We expect this phase to pass by early Q4, by which time growth will resume.

Our objective of reaching 10 million-plus DAU with Midu and Midu Light combined by year end and of becoming the biggest online literature platform and home market in 2020 remains unchanged. We remain confident about achieving the objective and given the better than expected start of Midu Light, the strong growth momentum of Midu we enjoyed in Q2, and the tremendous market opportunities lying ahead.

Turning to the second half of 2019 outlook, we will continue to grow our user base for Qutoutiao and to further strengthen Midu's leading position once normal operations resume by mid-October. Our year-end DAU target remains unchanged at 50 million to 60 million DAU for the group, which is about double the level at the end of last year. The overall digital advertising market is experiencing weakness this year due to the supply/demand imbalance and weak national conditions. Despite a much tougher operational environment, we are delivering one of the fastest growth rates in the industry.

We continue to diversify our monetization avenues, focusing on casual games and live streaming, which have been increasing their share of group revenues. Looking longer term, as we are far from realizing our monetization potential, our focus undoubtedly continues to be optimizing the efficiency of our app platform, which will drive structurally higher ARPU.

This concludes Eric's remarks. I will now read the prepared remarks of Jingbo.

Jingbo Wang -- Co-Chief Financial Officer

[Through translator] Despite the weakness in the ad market, which directly impacts us through pricing, our unit economics remain healthy. Our average user acquisition cost was RMB6.93. Our user engagement expenses for the whole group was RMB0.13 per DAU per day, while our ARPU was RMB0.39.

We continue to invest across the different products based on what we think makes strategic sense. We have invested heavily in Midu on the content front just before the suspension. As a result, it has a far better coverage of the high-quality books available in the market than any free-reading peer does. We have also built a very capable in-house editor team, which works with writers directly to generate original and differentiated content. We have seen pleasing performance data, which clearly showed that these original books have been well-received by the readers.

We have significant potential to further drive our monetization by improving the efficiency of our proprietary advertising platform, which we built last year, as the business grows, which diversifies our advertising inventories. Through the investment in technology and accumulation of data, we will be able to enhance the billing system and algorithms to close the gap between us and the established payers.

In the meantime, we are deepening our existing customer relationships as we build better understanding of our customers and deliver better results, as well as expanding into more advertiser industries to better match the ever diversifying ad inventories that are being added on to our platform. We are also making good progress on growing revenues from casual games and livestreaming.

This concludes Jingbo's remarks. Now, I will move on to Xiaolu's comments.

Xiaolu Zhu -- Co-Chief Financial Officer

[Through translator] Our revenue has recovered from a seasonal low of Q1 to reach RMB1.4 billion in Q2, which is close to three times higher versus the same period last year. This rapid growth is being driven predominantly by DAU growth and has been achieved against a backdrop of the weak overall advertising market, especially from a pricing perspective. The recovery since Q2 has progressed more slowly than what one would expect under normal market conditions, but we're not seeing any worsening trends.

ARPU, which we define as net revenues per DAU per day, was RMB0.39 in Q2 2019 compared to RMB0.33 in Q1 2019 and RMB0.42 in Q2 2018. The year-on-year decline has been driven by the faster growth of new products, such as Midu, which have lower ARPUs in comparison to Qutoutiao, and also the general weakness of the advertising market in China. Sequentially, we see meaningful ARPU growth across all products, which is a combination of favorable seasonality impact and structural improvement, as monetization of products grows.

Turning to costs and expenses, I will focus on non-GAAP measures, which exclude stock-based compensation. For Q2 2019, our gross margin was 74%, which declined 1.2% quarter-on-quarter, or 9.1% year-on-year, mostly due to our investment in IT infrastructure to better accommodate more bandwidth data-intensive content such as videos, livestreaming, and games. However, sequentially, our operating margin has improved by 18.7%, as we have kept our expenses under control while monetization improved.

Our user engagement expenses as a percentage of revenue have improved both sequentially and year-on-year as we have continued to bring down the absolute amount we pay to each active user every day, which will be stable and within the range of RMB0.15 to RMB0.20 for the Qutoutiao app.

Our ad load is at a healthy level, and given the potential for ad inventory to increase coming from our products scaling up, such as Midu, and subsequently the higher efficiency of our central ad platform manifested through higher click-through rates and cost per click, we're confident about the growth opportunities lying ahead.

R&D expenses were 13.3% of revenue compared to 12.4% in Q1 2019 and 7.9% in Q2 2018, as we continue to invest in talent and our core technological capabilities, which underpin our long-term competitiveness.

Other sales and marketing expenses amounted to 5.2% of revenue compared to 3% of revenue last quarter and 4.4% of revenue in Q2 2018. The increase was driven by our increased spending on brand advertising, which we believe will be more value-creating from her onwards given that we have reached a meaningful scale. G&A expenses were stable at 3.6% of revenue, in line with history.

Overall, our non-GAAP net loss was RMB496 million, representing a loss ratio of 35.8%, which has increased from a year ago, largely due to our increased investment in our IT infrastructure and higher user acquisition costs on a per new installation basis.

Looking ahead, in terms of guidance, and given that Midu has been suspended for new content updates and commercial activities since July 15th and will remain suspended for the rest of Q3, we will have very little revenue contribution from Midu this quarter. We do expect the business to resume regular operation by October 15th so the impact on Q4 should be small. And as discussed earlier during the call, our year-end traffic as well as revenue run rate targets for Midu remain unchanged given the strong growth momentum for Midu we have witnessed in Q2 and the better than expected start of Midu Light so far.

For Q3, based on our view of the market and the operating conditions, which are subject to change, we expect net revenues to be at a similar level as we have achieved in the second quarter. This has taken into account the short-term impact of lost revenues from Midu.

Finally, in terms of balance sheet, we are in a strong position, with RMB2.3 billion in cash, and we are confident this will support us as we take the business to the next level.

This concludes all our prepared remarks today. Now we are open for questions. Operator, please proceed.

Questions and Answers:

Operator

Thank you. Ladies and gentlemen, we'll now begin the question-and-answer session. If you wish to ask a question, please press "*1" on your telephone keypad and wait for your name to be announced. If you wish to cancel your request, please press "#". Ladies and gentlemen, once again, it's "*1" if you wish to ask a question.

The first question we have is from the line of Zhijing Liu from UBS. You may now ask your question.

Zhijing Liu -- UBS -- Analyst

Thank you, management, for taking my questions. We noticed that DAU was stagnant in Q2. Can you elaborate more on your user acquisition strategy on both Qutoutiao and Midu and their DAU change? Due to advertising and accounting upgrade suspension, Midu DAU and monetization will be under pressure in 3Q. I understand that you already launched a light version to offset some pressures. Can you elaborate more on current progress on how you deal with the Midu app issue? I'll stop here. Thank you.

Xiaolu Zhu -- Co-Chief Financial Officer

Thank you, Zhijing. This is Xiaolu. So, regarding your first question on DAU growth trends, I think we did discuss this a little bit in our last earnings call. We had some pressure in late Q1/early Q2 in terms of user growth due to irrational competitions in the market and also the overall weakness in ad markets. But we have since seen some recovery in terms of user growth starting from the second half of the second quarter, especially in June, and I would say that our user growth has since reactivated and that trend has been carried over to Q3.

In terms of Qutoutiao and Midu on a stand-alone basis, for Qutoutiao, I think we have seen some very healthy trends so far this quarter. DAU on a stand-alone basis increased, on average, about 10-15 cents compared to Q2 on a quarter-to-quarter basis. On the Midu side, I think, as we said in our prepared remarks, we had a very strong second quarter and the early results in the beginning of Q3 is also very good. The PPAU for Midu has reached over 8 million as of the beginning of Q3. However, we did have this suspension for Midu starting from July 15th. So, this will be trending for us in Q3. The suspension will last from July 15th until October 15th. So, the impact mainly was in Q3.

So, to your second question, regarding the Midu situation, we do have some additional efforts. First of all, we continue to expand our content library. We continue to be the No. 1 player in the free online literature market and we have a comfortable margin based on our third-party data. And also with the launch of Midu Light, we were able to keep our combined user traffic stable for Q3 compared to Q2, although the monetization has been stopped so the impact on the revenue side will be much bigger. Assuming that we have no growth from Midu in Q3, it still has, I believe, 8 million DAU. And assuming 30-35 cents income from ARPU, that means we are losing RMB2.2 million income from revenue per day for the entirety of Q3.

However, we do have better than expected start of Midu Light. So far, the traffic growth has been very strong. So, we were able to keep the combined user traffic of Midu and Midu Light at a stable level compared to Q2. And also with the additional loyalty program on Midu Light, the new app attracts a somewhat different user base compared to the original Midu app. And with that, we are able to increase ARPUs, as early results have showed. So, we are confident that both apps will do well once we do resume some operation and our year-end target of combined DAU of 10-15 million for Midu has not changed.

On the monetization side, I think Midu's potential has yet to be fully realized given the low ad load in the first half of this year and also the new opportunities from Midu Light. So, we believe, combined, the two apps will contribute potentially RMB2 million to RMB3 million per day in terms of revenue in Q4. Thank you.

Zhijing Liu -- UBS -- Analyst

Thank you.

Operator

Thank you. The next question we have is from the line of Alicia Yap from Citigroup. You may now ask your question.

Alicia Yap -- Citigroup -- Analyst

Hi. Good evening. Good morning, management. Thanks for taking my questions. I have a couple of questions. No. 1 is just to follow up on the Midu question. I wanted to understand how sure are you regarding the regulatory headwind that we are seeing could really relax and resume by mid-October.

And then if we look forward, in terms of when we can resume the monetization, how big do you think the Midu app revenue could grow into, in terms of percentage of total revenue contribution for Midu that you believe that could reach?

And then the same question just regarding the costs and expenses. So, we did see some cost control benefit. Right? User engagement coming down but user acquisition and content procurement costs seem to be going up a little bit. So, can you help us understand what will be the expense trend for the second half, in terms of the content and user acquisition and user engagement? So, any color on the direction, that would be helpful. Thank you.

Xiaolu Zhu -- Co-Chief Financial Officer

Thank you, Alicia. I think, regarding your first question, we are quite confident that Midu will resume normal operations by October 15th. We also received an internet news license recently. So, this is the first license issued since early 2017 and the first and only issued in Shanghai, which means that our efforts from the very beginning through our content compliance teams and capabilities has been well-recognized by the regulators. And I think based on our understanding of our communications with the regulators, we are quite confident that the impact on Midu in Q4 will be limited.

Regarding your second question, in terms of revenue contribution, as I said previously, we do see a very healthy traffic growth of Midu in Q2 and early Q3, and also we had a very strong start of Midu Light so far this quarter. So, I think in Q4, we do have very high expectations for Midu. And with the current trends, we see that Midu can contribute up to 20% of our total revenue in Q4.

In terms of your third question, regarding costs and expenses, I think several things. First, for content costs, given the nature of our business, we believe we will be able to control the content costs at a 6% to 7% level, as a percentage of revenue, on the Qutoutiao side, and around 20% on the Midu side, respectively. As the head contributors come from a large share of users compared to other content formats, while the tail is low and fat for both newsfeed and online literature. We are confident to keep our content costs at the current level in the near future.

For user acquisitions, it has stayed at RMB6 to RMB7 per installation level for several quarters and we don't see any big changes for the rest of the year. In terms of engagement costs, I think this quarter we were able to further reduce our average user engagement costs to RMB13 cents per DAU on a blended basis, compared to 17 cents in Q1 and over 20 cents in the second half last year. The reduction is a result of our improved algorithms, through which we can focus our engagement budget on users that are most susceptible to catch stimulation and also an effect that we intentionally cut back some of the costs during low season and in the phase of irrational competition in Q1 and Q2.

For Q3 and Q4, we expect our average engagement cost per DAU to increase a little bit due to seasonality and better monetization on the ARPU side, but still below compared to the same period last year and to be around 15 cents per DAU on a blended basis. Thank you.

Alicia Yap -- Citigroup -- Analyst

Okay. Thank you.

Operator

Thank you. The next question we have is from the line of Hans Chung from KeyBanc Capital Markets. Your line is now open.

Hans Chung -- KeyBanc Capital Markets -- Analyst

Thanks for taking my question. So, I have a couple of questions. First, can you give us some color around your view on the 4Q revenue outlook? And then I remember last quarter, we had annual guidance for 6 to 7 and I just wonder if that guidance still maintains. And then, secondly, it seems like the engagement ratio, which is DAU to MAU, and also the conversion from installed user to MAU, if you look at the two metrics, they both came down quite a bit in the second quarter. So, I just wonder what drove the trend and how should we think about the trend to get us stabilized going forward? Thank you.

Xiaolu Zhu -- Co-Chief Financial Officer

Thanks, Hans. So, regarding the revenue outlook and guidance, I think if you look at our Q3 numbers, as we explained that we have almost little to zero revenue contribution from Midu this quarter. So, our guidance for this quarter is that we are expecting Q3 revenues to be on a similar level of flattish compared to Q2 on a quarter-over-quarter basis. That means Qutoutiao app alone will contribute revenues on a similar level as Qutoutiao and Midu combined in Q2.

So, for Q4, I think once Midu resumes normal operations, and also as I explained in the previous question, we believe Midu can contribute as much as 20% of our total revenue. We do think that Q4 will be a strong quarter for us in terms of revenue growth.

And regarding the overall annual guidance, I think so far every trend is growing as we expected and as we have discussed with the market before. But there is a loss of revenue in Q3 from Midu so I think the main difference will be that part. Otherwise, we think we have strong confidence in achieving our other annual goals. Especially on the traffic side, we are still very confident that we can achieve our goal of year-end DAU of 50 million to 60 million.

In terms of your third question regarding engagement ratio, I think we have touched upon that a little bit previously as well. We had some pressures in the first quarter and the first half of the second quarter due to irrational competition and the overall weakness of the ad market. However, we did make several efforts in terms of optimizing our user engagement costs and also increasing the quality of our content. And we have seen some very promising early results starting from the second half of Q2, especially starting from June.

And as I explained, we have seen a 10% to 15% user traffic growth in Q3 so far compared to Q2 and we believe the trend will continue. And also in terms of Midu, despite the suspension, we have a very strong start of Midu Light, so combined traffic of Midu and Midu Light stays flattish compared to Midu in Q2. And I think we can restart the growth of Midu once the normal operations resume. So, overall, I think we are still very confident in terms of achieving our year-end goal of 50 million to 60 million DAUs and the pressure we had earlier this year, we don't think it's a long-term thing. Thank you.

Operator

Thank you. The next question is coming from the line of Tian Hou from T.H. Capital. Your line is now open.

Tian Hou -- T.H. Capital -- Analyst

Yes. So, two questions. One is regarding the retention rate. So, what is the current retention rate of the two apps combined? And also what is the target retention rate by the end of this year since the newer app, Midu, is going to come back live? So, that's going to be really helpful to retention. So, that's the first question.

The second question is related to advertising and advertisers. So, in Q3, what are the newer or growing sectors of advertisers? What are the decreasing sectors of advertisers? So, what trends do you see in the advertising sector front? That's two questions. Thank you.

Xiaolu Zhu -- Co-Chief Financial Officer

Thank you, Tian. Regarding user retention, as I said earlier, we did see some pressure in the first half of this year as we continued to optimize our user engagement profile while facing irrational competition in the market at the same time. And March and April were the low points for us. For Q1, we saw a downward trend but for Q2, we have ended the quarter on a higher mark. Quarter-end DAU exceeded 40 million and the strong momentum continued in Q3. And also as I said earlier, we see average DAU for the two Midu apps have increased over 10% so far in Q3 compared to the second quarter.

Regarding the user acquisition costs, as I explained earlier, we are trying to keep that cost down to the 6 to 7 RMB range and we don't have any plans to increase that budget on a large scale. So, overall, I think we are trying still to continue to increase our content quality, continue to optimize our operations and to offer more social features, video games, live streaming, and expect to add also all kinds of new content features on the Qutoutiao side to increase user engagement and activity. And, so far, we have seen some very strong early results. And as I said, our year-end target of 50 million to 60 million DAU has not been changed. So, so far, we are quite confident in terms of user traffic growth and user retention.

In terms of your second question, regarding the advertisers, so far this year, e-commerce has been quite strong and continues to be the largest segment of our advertisers. Otherwise, I think most segments are more or less the same as previous quarters. And we think that this trend will continue for the rest of the year. Thank you.

Tian Hou -- T.H. Capital -- Analyst

Thank you.

Operator

Thank you. As there are no further questions, I will now like to hand the conference back to the company for closing remarks. Again, if there are no further questions, I'd like to turn the call over to the company for closing remarks.

Sai Chi -- Qutoutiao Inc.

Thank you, everyone. That concludes today's conference call. Thank you.

Xiaolu Zhu -- Co-Chief Financial Officer

Thank you.

Duration: 34 minutes

Call participants:

Sai Chi -- Qutoutiao Inc.

Eric Tan -- Chairman and Chief Executive Officer

Jingbo Wang -- Co-Chief Financial Officer

Xiaolu Zhu -- Co-Chief Financial Officer

Zhijing Liu -- UBS -- Analyst

Alicia Yap -- Citigroup -- Analyst

Hans Chung -- KeyBanc Capital Markets -- Analyst

Tian Hou -- T.H. Capital -- Analyst

More QTT analysis

All earnings call transcripts

This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.

10 stocks we like better than QUTOUTIAO INC
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has quadrupled the market.*

David and Tom just revealed what they believe are the ten best stocks for investors to buy right now... and QUTOUTIAO INC wasn't one of them! That's right -- they think these 10 stocks are even better buys.

See the 10 stocks

 

*Stock Advisor returns as of June 1, 2019