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Qutoutiao Inc (NASDAQ:QTT)
Q3 2019 Earnings Call
Dec 3, 2019, 8:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Hello, ladies and gentlemen, thank you for standing by, and welcome to the Third Quarter 2019 Earnings Conference Call for Qutoutiao Inc. [Operator Instructions]

I will now turn the call over to your host Sai Chi Du [Phonetic]. Please go ahead, sir.

Sai Chi Du -- Investor Relations

Thank you very much. Welcome everyone to the third quarter of 2019 earnings conference call of Qutoutiao Inc. The company's financial and operational results will be -- were released by 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 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 US 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 US 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. I will start by reading out Eric's commentary on the business.

I would like to first review the business for the third quarter and then provide some outlook for the last remaining quarter of the year, and further beyond. For the review part, I will go through the key highlights in growth, content, US economics, before touching on Midu's development in a bit more detail. Despite less than hospitable operating environment, which has persisted for much of the year, we have pushed on with determination as well as agility. Our DAU has reached 42 million, which has doubled from the level a year ago, while our MAU has also shown a similar leap. Irrational competition early in the year and a weak advertising market had caused some impact on our growth trajectory, neither has dented our core capabilities, and we have taken advantage of the slower market to not only initiate organizational improvement and invest in our people and technology. We have also made meaningful progress on product suite expansion.

The most notable of which is Midu Lite, which commenced in May, and has quickly gathered more than 3 million DAU. To further strengthen our competitive advantage, we continue to build our content ecosystem both for Midu and QTT. During the third quarter, we expanded and deepened our cooperation with content producers. Most notably, iReader also known as Zhangyue, which is currently the largest single online literature platform in China. Our users will be able to enjoy both quality content coming from iReader as well as the personalized and enhanced reading experience facilitated by our AI platform.

On the QTT side, we have further made efforts to upgrade our content duration by establishing permanent connection to the public ID verification system of the Police Department, which allows our platform to automatically screen out the inevitable count. The result has been a determination of more than 10,000 content provider accounts since July, and the significant reduction of negative feedback in users. Additionally, there have been targeted initiatives aiming at strengthening content offerings for specific categories such as games, dancing in public squares, health, entertainment news and etc. Through our collaboration with prominent media groups in the entertainment space, we are signing up celebrities as content contributors. Our users will continue to enjoy the progress in our content offerings in terms of both richness and quality.

Content improvement is a key ingredient for better user retention and monetization. Both of our short-term and long-term retention rate in the current quarter are at least 10% better in relative terms in comparison to the first half of this year, consistent with the trend of rising time spent observed in the quarter.

ARPU trends have been muddied by the temporary suspension of Midu Novels, but if we look at QTT on a stand-alone basis, there has clearly been sequential improvement. Diversification of revenue streams is also progressing nicely, with revenues generated from games and live streaming both more than doubled quarter-on-quarter. We now have 10% to 20% of our users accessing games and around 3% of users active on live streaming on a daily basis. The significance of diversification is not just enhanced monetization potential, but also an expansion and enrichment of the overall Qutoutiao ecosystem, essentially becoming more relevant and indispensable for more people over time, and this is pulling the synergy lever to improve long-term retention rates and grow user time spent, being able to structurally increase retention both at the long and the short end, gives us confidence that we are pushing in the right direction.

We're also stepping up the monetization efficiency of our proprietary advertising platform by transitioning into an OCPC [Phonetic] system, which is supported by strong AI and data capabilities as well as close partnerships with our customers, built on mutual trust and our consistent delivery of value-added services. In comparison to the traditional CPC system, it has the benefit of further derisking advertising customers budgeting process by offering more precise and tailored traffic allocations taken into account customers overall return requirements. This allows customers to increase spending with even better results and allows us to accelerate the evolution of our ad tech, as we keep optimizing the process, enhancing our core competitive advantage and deepening our client relationships over time. With better retention and stronger monetization engine and ARPU improving, we shall see better ROI driving our business going forward.

Now on Midu, as you know, for the most part of the third quarter commercialization and content upgrade have been suspended for Midu Novels. However Midu Lite, driven by superior US economics even at the steady stage of development has quickly grown to become a strategically important pillar of the Midu franchise. As the differentiated design, which incorporates the loyalty program in addition to the standard offer of Midu Novels, it is inviting many who have zero experience with online literature to give it a try, and consequently developed a passion for reading.

Our data support is observation, at the overlap between Midu Novels and Midu Lite is negligible despite them both being of a reasonable size already as we speak. Given the highly complementary nature of the two apps in relation to each other, we will promote them equally going forward, as together they allow us to more effectively target both the existing reading population and potential reading population, achieving full coverage of the entire market from a product perspective.

The broader significance of this development is that it will lead to an acceleration in the inevitable structural shift of the industry from a paid-only model to ultimately a premium model as the availability of the right offerings will quicken the popularization of the free-to-read concept and the awakening of the potentially huge demand from the addressable market, still largely unaddressed. Despite going through a tough period recently, Midu received around the financing led by CMC Capital Partners, which is a recognition of the solid fundamentals of the business and its long-term growth potential, and we are grateful for CMC support and trust. Our target is to become the largest online literature platform in China in the next quarter or two with more than 10 million DAU, from which point onwards, we will increasingly gain brand value in the minds of both content providers and readers, feeding a virtuous cycle of ever expanding content library, user base and monetization potential, which will further strengthen our leadership position in the industry.

Finally, in terms of the outlook for the future. We firmly believe that the lower-tier cities remain the most attractive space today with unmatched structural potential for growth and monetization. One notable effect that has come to my attention recently, which I would like to share is that during the Double 11 Shopping Festival, GMV generated by Qutoutiao users on e-commerce platforms increased more than tenfold in comparison to last year. We are in privilege to job observing a huge historically on the sub population and we certainly intend to more than keep up with that -- with what our loyal users expect of us.

Our priority is not simply growth, but rather long-term profitable growth. We intend to respond to market fluctuations with a reason and gain comfort in remaining focused on doing the right things that will ultimately matter and that means a balanced approach to growth and capital allocation with an emphasis on sustainability. Thank you very much. That concludes Eric's remarks, and I will now read our CFO's comments.

We generated RMB1.4 billion revenues in the third quarter of 2019, which is an increase of 44% in comparison to the same period last year. Sequentially, revenues are up slightly, not fully reflecting the underlying improvement in the business, and the overall market, as we experienced, mainly due to the loss of revenues from Midu Novels, as a result of the three month suspension between mid-July and mid-October. The suspension has now been fully lifted, but we are not in a rush to ramp-up growth yet as we have been taking the opportunity to refine our product design and recalibrate our longer term strategy. We expect some time before Midu's revenues to fully normalize.

Our ARPU, which is defined as revenue per DAU per day was RMB0.36 in Q3 2019 compared to RMB0.39 in Q2 2019 and RMB0.51 in Q3 2018. The year-on-year decline has been driven by the general weakness of the advertising market this year as well as the loss of revenues due to Midu Novels suspension. Sequentially, however, we have seen growth on a like-for-like basis, consistent with seasonal tailwinds and structural improvement in our ability to monetize.

Turning to costs. I will focus on non-GAAP measures, which exclude stock-based compensation. For Q3 2019, our gross margin was 65% compared to 84% in Q3, 2018. The decrease was due to three factors. Firstly, there was the loss of revenues from Midu Novels which was not commensurate with the amount of savings on the content cost side. Secondly, there was a negative mix impact from the growth of the low margin integrated and customized marketing solution services. Thirdly, we have increased investment in content and IT infrastructure to support the increasing richness of our content as demonstrated by the right and share of videos, games, and live streaming, and our users consumption mix.

Our user engagement expenses on a per DAU per day basis have almost halved from RMB0.25 a year-ago to now RMB0.14. We intend to keep it at close to this level for the near future, given the material reduction achieved in a relatively short period of time. Core to what has made this possible is the enhanced the value proposition of our products as well as the result of our ongoing investment into our content, technology and people.

As a percentage of revenues, user engagement expenses were 38%, which was 11 percentage points lower in comparison to last year, despite the temporarily suppressed revenue base we enjoyed during the quarter.

Our user acquisition expenses were RMB6.58 per installation, which was 5% lower quarter-on-quarter, as we benefited from the generally weaker advertising prices in the market. As Midu Lite has grown rapidly during the period, which required investment to support user acquisition, our overall spending in absolute amount in this area has stayed flat sequentially.

Other sales and marketing expenses were 12% of revenues, which was higher year-on-year due to the temporary reduced revenue base as well as our increased spending in brand advertising. We believe that given our current scale and leading position in the industry, brand campaign is a sense for additional marketing strategy, as increased awareness of our name should encourage natural inflows of users, and potentially word-of-mouth effect which can accelerate such natural traffic.

R&D expenses were 16% of revenues in the quarter, which was generally in line with Q2 2019, and higher than the 7% in the same period last year. Again to certain extent affected by our suppressed revenues, in addition to our increase in capital allocation to technology and talent. G&A expenses were 4% of revenues in the quarter, generally in line with history. Overall, our non-GAAP net loss was RMB833 million, representing a net loss ratio of 59% which was increased from a year-ago, largely reflecting the impact from the suspension of Midu Novels and investment required by the fast growing Midu Lite, and to a lesser extent, our investment in IT infrastructure.

This quarter, we have also completed the issuance of new shares to The Paper, also known as Shanghai Jifen, pursuant to the agreement, we entered into before our IPO. More details of this transaction can be found in our most recent Form F-3, filed mainly for the purpose of this transaction.

Our balance sheet remains strong with RMB2.1 billion cash as of September 30, and we remain confident that we are well supported to continue to grow and invest for the future. As Eric has already discussed, we would like to take a more balanced approach between growth and profitability going forward. Our most mature and biggest business line QTT has already seen a healthy uptick in operating margin in the second half of 2019, with a strong performance so far in the fourth quarter, we now expect this business line to breakeven in 2020 on a stand-alone basis.

Now for the fourth quarter, we are seeing better unit economics, as a result of better user retention, as well as better ARPU on the QTT side, which we believe will be sustained throughout the fourth quarter and beyond. Together with better economics, we expect our margins for the entire company in Q4 to also recover to a level better than what we achieved in the second quarter of this year.

For Q4 revenue guidance, based on our view of the market and the operating conditions which are subject to change. We expect net revenues to be in the range of RMB1.6 billion to RMB1.62 billion. This has taken into account the resumption of normal operations on Midu Novels for the latter half of the quarter.

That concludes our prepared remarks today. And now we are open for questions. Operator, please proceed.

Questions and Answers:

Operator

Certainly sir. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] We have the first question coming from the line of Zhijing Liu from UBS. Please go ahead.

Zhijing Liu -- UBS Investment Bank -- Analyst

[Foreign Speech]

Let me translate myself. Thank you, management for taking my question. I have two questions. The first one is, we see COGS in 3Q had a surge of over 200%. The official explanation is QTT have a newly integrated and customized marketing solution services. Can you introduce this new business and the reason for integration. The second one is, how do you look at a competition of free-reading market or competitors like SINA [Phonetic] and [Indecipherable] had a quite good momentum as Midu, and just to have a new round of financing, will you guys maintain your marketing and user acquisition at a high level? Thank you.

Xiaolu Zhu -- Co-Chief Financial Officer

Hi. Thank you Zhijing. This is Xiaolu. Regarding our first question in terms of gross margin, I think it's a combination of several factors, especially if you look at the year-over-year numbers. The number one factor is, obviously the loss of revenue from Midu. This loss of revenue has skewed our margin across line in Q3. The second reason is the content costs on the Midu side, as you know, there are certain upfront payments for working with content providers like iReader, we make our investment decisions based on the normal cost of our business and the suspension of Midu, came as a surprise to us, but we choose to not interrupt the normal operation of our business, given the lack of time for preparation and notice. So we continue the content expenditures in Q3.

The third reason is additional costs associated with content compliance. This is something that we have putting a lot of efforts, so far this year. But I think this part of cost should be stable going forward. The fourth reason is that, as you mentioned there is a small amount of our revenue in Q3 have a lower gross margin, this is -- then this that we start to provide to our third-party partners for general advertising platform services. This is still a small part and we don't think this will be a big part of our revenue going forward. The fifth reason is the change of user preference, especially in the content format side, now more videos are being viewed every day by our users. The majority, over 50% of our advertising are delivered through video, which means that it requires a more infrastructure build up such as servers and bandwidth and also different AI computing resources.

So I think the decrease in gross margin this quarter is a combination of several factors, as I just explained. And the biggest problem here is there is a loss of revenue from Midu in Q3. So we believe that our gross margin will be back to over 70% in Q4 and beyond, as the impact of the Midu suspension is smaller in Q4 compared to Q3.

Also if you look going forward, I think there will be more leverage content cost as a percentage of revenue will decrease as Midu's revenue increase, IT infrastructure related costs should be stable and our content compliance cost should be stable as well. So overall, I think for the next year, we will see a gross margin over 75%.

To your second question regarding the competition of Midu, I think despite the suspension in Q3, we continue to be the number one player in the free online literature market with a comfortable margin based on third-party data we have seen. Our goal to become the number one player in the entire online literature market has not changed. It's actually with the launch of Midu Lite, we were able to keep our combined user traffic to be stable for the entire Q3. So our -- the combined DAU of Midu and Midu Lite, is still over 8 million as of now. The other thing that with the additional royalty feature on Midu Lite, the new app attracts somewhat different user base compared to the original Midu app. And also with this royalty program, we are able to increase the ARPU of Midu in Q4. So, and combined, the two apps now contribute to close to RMB3 million per day in terms of revenue for the first week of December, and we see continued clear path toward profitability, especially on the Midu Lite side with higher ARPU next year. Also overall, the user overlap between Midu and Midu Lite is very small, at around 2%. Midu Lite is able to attract users new to online literature because of its loyalty feature. So we believe both apps has a long-term strategic value for us, and we believe it will help us to capture a bigger share of the market. Thank you.

Zhijing Liu -- UBS Investment Bank -- Analyst

Thank you very much.

Operator

Thank you, sir. We will move to the next question now. The next one comes from Alicia Yap. Please go ahead.

Alicia Yap -- Citigroup Inc -- Analyst

Hi. Good evening management. Thanks for taking my question. [Foreign Speech]

I have two questions. The first one is related to the softness for the fourth quarter guidance. So I understand, that is part of it is related to the Midu app revenue, kind of rebounding, maybe taking a bit slower. So I just wanted to get a bit more sense in terms into next year, how should we think about this 4Q guidance that indicated for -- as we go into 2020. Should we expect the revenue growth rate could reaccelerate in the later half of 2020 as we lapse out this fiscal half.

The second question is a little bit follow-up on the competitive landscape on the free-reading app. So I think just now management already mentioned, quite a bit of the strategy, the differentiation, but just wanted to get a bit more color in terms of the differentiation between the apps, like what could be the attractive points for the user to come to Midu app versus other free-reading apps out there. So what are the special criteria or the special attractive points that Midu app has that other competitors doesn't have that allow us to attract the user. [Foreign Speech]

Xiaolu Zhu -- Co-Chief Financial Officer

Thank you, Alicia. I think regarding our first question, yes, I think -- it took some time for the Midu app to get back into full stream after the end of the suspension. As I already said, right now, the revenue run rate is at RMB2.5 million to RMB3 million per day. So I would say that for December, we have had Midu back. But in the early part of Q4, yes, we did have some impact from the previous suspension and which suppress the revenue from Midu. But overall, I think we have seen a very strong performance, especially in the second half of Q4.

On the QTT side, we see continued growth, with new features including short video, live streaming, leisure games are contributing. As of today, I think 70% of our users already played some video games on the QTT app, without us making any big promotions, and our game publishing and live streaming is already starting to provide new monetization channels for us. In Q4, the contribution from these channels are still in the low single-digit, in terms of estimates of total revenue, but they are ramping up very quickly with better monetization comes better ROI. I think over the longer term, this will allow us to invest for more future growth. So combined, we continue to see very healthy growth in Q4 2019.

However, as discussed in the prepared remarks, overall, we will make a more balanced approach between growth and profitability. We now see a clear -- much clear path toward profitability in 2020. Especially on the QTT side, we believe with this disciplined expense control, QTT on a stand-alone basis we will be able to achieve breakeven on a quarterly basis in the second half of 2020. And if we do it well for the entire company, as well.

So starting from this quarter, we are taking a more stringent approach in terms of user acquisition. As now, all our new investment for user position needs to meet the six months payback period threshold, which means that we asked our team to get our initial investment back within six months. This is a much stringent requirement compared to previous quarters. So unless we see real compelling new opportunities, we will stick to the current plan, and to put more focus on sustainability and the long-term profit both growth in Q4 and beyond.

As to your question regarding next year, especially second half next year, yes, obviously given the loss of revenue in Q3 for Midu, I think on a like-for-like basis next year, second half, we probably will see accelerated growth. And also, if we do things, right, we will be able to reinvest the profit back into the business in the second half of 2020. But overall, I think we will took up -- we will take a balanced approach. So, the health of the business -- the long-term sustainability first, then there will naturally come the growth.

Regarding your second question, the competition with other players in the online literature market, I think we have Midu and the Midu Lite, one, two punch, we were able to cover vast user base, especially in the lower-tier cities. In terms of our content library, as we have discussed in our prepared remarks, we have signed -- basically every big major content providers other than China Literature in the market, especially our cooperation with iReader is very comprehensive. So we do have the most comprehensive content library in the market, as of now.

Our second advantage is our data and algorithm. So, from our experience, as a newsfeed provider, we were able to match our users interest with the most precise content. The third thing is that this loyalty program we have on the Midu Lite side, which allows us to attract a different user base, especially users new to the online literature content, and I think with these three factors combined, we will be able to continue to lead in this market. Thank you.

Alicia Yap -- Citigroup Inc -- Analyst

Thank you.

Operator

Thank you. [Operator Instructions] We have the next one coming from the line of Hans Chung. Please go ahead with your question.

Han Chung -- KeyBanc Capital Markets Inc -- Analyst

Good evening. Thank you for taking my questions. So just quick question regarding the fourth quarter. Can management give more color around the key assumption on the user matrix. For example, like the MAU, DAU and then on both the QTT and the Midu. And also what's the ARPU trend on the sequential basis and then perhaps the -- our view on the cost side -- what would be the operating loss for the fourth quarter? Thank you.

Xiaolu Zhu -- Co-Chief Financial Officer

Sure. I think for the fourth quarter, as I said we will -- we plan to take a balanced approach. So this will -- this means we will prefer a long-term sustainable growth. And as I said, we will take a more stringent approach in terms of user acquisition. And so I think for Q4, probably we see slower user base increase compared to our previous quarters.

In terms of ARPU, on the QTT side, the ARPU trend is already quite strong, especially for Q3, and so far in Q4. On the Midu side with the back-to-normal operations, the ARPU for Midu is obviously -- will be better compared to Q3. So overall, I think we will see a slight increase in terms of traffic, better ARPU. And overall, we will see a sequential increase in terms of revenue from Q2 and Q3.

And in terms of bottom line. I think with a more disciplined approach in terms of investment, we will see better margins in Q4 as well. For now, I think we believe that the Q4 loss will be smaller compared to Q2, in terms both of in absolute dollar amount and also in terms of margins. Thank you.

Han Chung -- KeyBanc Capital Markets Inc -- Analyst

Thank you.

Operator

Thank you. We have the next question coming from the line of Thomas Chongo [Phonetic]. Please go ahead.

Thomas Chongo -- Analyst

Hi, good evening. Thanks management for taking my questions. I would like to ask about the long-term KPI for our company, in particular, how should we think about the revenue per DAU over the long-term. And also, how should we think about the daily active users in the long-term. Do we have any KPI [Phonetic] of our [Indecipherable] [Foreign Speech].

Xiaolu Zhu -- Co-Chief Financial Officer

So in terms of ARPU, I think this year, we have seen some less than hospitable operating environment especially under the macro headwinds. So if you look our ARPU this year and compare it to last year, I believe that in the second half last year, our ARPU is over RMB0.45. To be more specific RMB0.50 in Q3 and RMB0.47 in Q4 in 2018. So I think it's possible that we can get our ARPU back to their levels somewhere down the road, but I think it will take some time and it will also depends on the overall economic landscape in China as well.

In terms of total user base, I think we still believe that lower-tier cities remain the most attractive space today with unmatched structural potential for growth and monetization. However, as I said, we want to take a more balanced approach regarding growth and profitability down the road. So I think we still have a high expectation for the long-term DAU and MAU target. But I think we now will probably pace our growth together with no profitability. Thank you.

Thomas Chongo -- Analyst

Thank you.

Operator

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

Sai Chi Du -- Investor Relations

Thank you very much for joining today's call, and please don't hesitate to reach out to our Investor Relations team for any further questions. That concludes today's call. Thank you.

Operator

[Operator Closing Remarks]

Duration: 37 minutes

Call participants:

Sai Chi Du -- Investor Relations

Xiaolu Zhu -- Co-Chief Financial Officer

Zhijing Liu -- UBS Investment Bank -- Analyst

Alicia Yap -- Citigroup Inc -- Analyst

Han Chung -- KeyBanc Capital Markets Inc -- Analyst

Thomas Chongo -- Analyst

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