Qutoutiao, Inc. (QTT) on Q4 2020 Results - Earnings Call Transcript

Qutoutiao, Inc. (QTT) Q4 2020 Earnings Conference Call March 4, 2021 7:00 AM ET

Company Participants

Sai Chi Du - IR

Xiaolu Zhu - CFO

Conference Call Participants

Vicky Wei - Citigroup

Operator

Hello, ladies and gentlemen. Thank you for standing by for the Fourth Quarter 2020 Earnings Conference Call for Qutoutiao Incorporated. [Operator Instructions].

Today's conference call is being recorded. I will now turn the call over to your host, Sai Chi Du. Please go ahead, Sai Chi.

Sai Chi Du

Thank you very much, and welcome, everyone, to the Fourth Quarter 2020 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 CEO, Mr. Eric Tan; and our CFO, Mr. Xiaolu Zhu.

Before we continue, please note that today's discussion will contain forward-looking statements made under the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, the company's results may be materially different from the views expressed today.

Further information regarding these and other risks and uncertainties is included in the company's prospectus and other public filings as filed with the U.S. Securities and Exchange Commission. The company does not assume any obligation to update any forward-looking statements, except as required under applicable law.

Please note that Qutoutiao's earnings press release and this conference call includes 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 first. Thank you, Sai Chi, and thanks, everyone, for joining today's conference call. This year of 2020 has been transformational for the world as well as for us. We have weathered more uncertainties and changes in the operational environment than ever before. This has tested our resiliency and adaptability and also pushed us to rethink how we should position our business and products.

At the heart of our thinking is how we maintain and improve unit economics. That part has not changed. What we are now doing differently is the path we take to achieve it. The value we create for our users comes from quality content distributed through the power of smart algorithms.

Naturally, this proposition is most valuable to those who come to our platforms solely for the purpose of consuming quality content. We pioneered loyalty points as a marketing strategy to reward our loyal users and enhance user engagement which has been effective, but the flip side of the same coin is that inevitably, there is a proportion of users whose reason for being on the platform is predominantly to earn loyalty points.

Not that it is a meaningful amount of money, but rather it is a gamified experience some people do enjoy, perhaps no less than consuming content. There is a clear gap between the unit economics of users who are content-oriented and those who are not.

While we have consistently invested into generating better and richer content to better serve and retain the former, we have also taken a firm and decisive step in slashing loyalty points to part ways with the latter. But the overall result, as you can imagine, is a user base of much better quality.

Unit economics has been structurally improved, driven by both the favorable user mix shift and the immediate cost savings. Naturally, our DAU and MAU figures point to a leaner user base throughout the year as we strategically turn the user base. But our revenue in the fourth quarter has shown a strong recovery from the third quarter and was at a comparable level to the first 2 quarters of the year.

Comparing with the first 3 quarters average, our ARPU in Q4 tells the story of this remarkable underlying transformation of our business profile. There has been an almost a 30% increase. When you look at the net ARPU, which is our headline ARPU, less user engagement expenses per DAU per day, it's even more remarkable, a 63% improvement. All else being equal, this goes directly into a much better unit economics.

Partially offsetting the ROI equation is a higher user acquisition expense we saw in the fourth quarter. Essentially being able to generate higher net ARPU gives us more ammunition to bid for high-quality users coming from higher quality channels. This is how we are driving a virtuous cycle going forward in 2021 and beyond.

One significant event for us during the quarter was a new round of financing for Midu Novels amounting to $110 million. Our consistent investment in content, and in collaboration with the industry leaders, will see us consistently strengthen our ecosystem.

The free-to-read online literature sector, being a large content subsector, does not yet have a clear winner, but still has the room to build a multibillion-dollar business. It's getting more recognized and understood by the market, and we see more general optimism around its long-term potential.

We continue to explore the monetization potential of original IP by expanding our in-house IP production through directly signing authors and the promotion of many dramas. The results have been encouraging. We expect Midu Novels to double in size by the end of this year in terms of both DAU and revenues.

Apart from the strategic development, the operational focus for us in 2020 has been the underlying profitability of the business. We are delighted to see the group turn operationally profitable in non-GAAP terms in the fourth quarter of 2020, the first profitable quarter since our IPO. In fact, the relatively more mature part of our business, which excludes Midu Novels, generated more than RMB100 million operating profit in Q4.

Despite the more challenging environment as a result of the CCTV program and the pandemic impact, we remain committed to creating true value for our users and building a healthy and sustainable business, and have seen our effort paying dividend. We expect to maintain and grow our profits from here onwards.

So looking out to this year, 2021, apart from doubling Midu Novels, we expect our overall user base and revenues to expand from the fourth quarter 2020 run rate. We will be pulling the same levers as we have successfully done so far, namely: Continue to invest in content quality; use better technology and use technology smartly to enhance overall user experience across our entire platform.

For the full year of 2021, it's not without challenge as we are still relatively young as a company and the operating environment is highly competitive. But with the right strategy and hopefully a stable macro environment, we believe our goal of full year group level profitability is well within reach.

Over the long term, we remain committed to our focus on the lower-tier cities in China, which is where the growth potential for smart phone users and disposable income is. We will grow with our users and provide high-quality content to meet our users' needs.

Thank you very much. That concludes Eric's remarks, and I will now turn the call over to our CFO, Xiaolu.

Xiaolu Zhu

Thank you, Eric and Sai Chi. And again, thank you, everyone, for joining today's call. Let me first review our financial and operational results with you before providing outlook for the next quarter and also our thoughts on the full year.

Our net revenues in the fourth quarter were RMB1.302 billion with an ARPU of RMB0.44, which is a significant sequential improvement. We had an average of 32 million DAU and 125 million MAU during the quarter. Our focus for the year 2020 has been enhancing operational efficiency and profitability, and we have been well on track. After consistently improving our cost-to-income ratios, we turned profitable on a non-GAAP operational basis for the first time since IPO in the fourth quarter of 2020.

So let's look at costs and expenses in more detail. Please note, I will be referring to non-GAAP measures which excludes stock-based compensation. Cost of revenues were RMB441.7 million in the fourth quarter of 2020, a decrease of 12% year-on-year, driven by our disciplined approach towards managing the fixed components, partially offset by our increased investment into content.

As a result, our gross profit was RMB860.7 million with gross margin slightly lower year-on-year at 66%, a strong reading considering the revenue headwind we encountered throughout the year. Our biggest expense is sales and marketing, which is mainly composed of user engagement expenses and user acquisition expenses. During the quarter, they came to RMB163 million and RMB397 million, respectively.

Our link new operational mode has produced material improvement on both of these line items and saw the total sales and marketing expense more than halving year-on-year in absolute dollar terms to RMB680.3 million and a significant reduction as a percentage of revenue from 82% a year ago to now 52.2%. In other words, our prudent management of sales and marketing activities have produced a 23 percentage point improvement in our underlying operating margin. Our R&D expenses were RMB199.7 million during the quarter, which was 12% of revenue, a small decrease as a percentage of revenue as a result of our streamlining of R&D teams.

G&A expenses were RMB94.4 million in the quarter, which was just under 4% of revenues, in line with the range we observed throughout the year. As a result, despite all the headwinds we have endured, we achieved our first quarterly profit since IPO, which came in at RMB42.5 million at 3% operating margin.

It was also the first quarter since IPO, during which our operating cash flow has turned positive, which will increasingly drive the strength of our balance sheet and provide a meaningful source of funding to support our investment and future growth.

I'd like to also comment a bit on our DAU and MAU trend. As Eric has already said, this is the result of aggressively cleaning up the low-quality users and to improve unit economics of our business.

Low-quality users, meaning users attracted to our platform mainly or even purely for the royalty points, but not for the content and experience we offer to our regular users. These low-quality users took a lot of the loyalty points we offered previously, but contributed very little to our advertising customers and to our top line.

So this has been an ongoing process throughout 2020 as we continue to improve the quality of our content, the algorithms of our recommendation engine and the overall experience we offer to our users. As a result, we have seen significant savings from our user engagement expenses, which now stands at RMB0.05 per day per user, only about 20% from the previous peak.

And especially in Q4 2020, with the recovery of our revenues, we have also seen a strong improvement in ARPU, which is the revenues we get from each user on a per day basis. This shows that our drive to improve user quality has been very successful, that we have kept the real users that matter and squeezing out the low-quality users. As a result, we now have a much better user economics as well as an overall healthy business model.

The key parts of the process were completed in the second half of 2020, and our Q4 DAU average was not far from the quarter end numbers of Q3, which means the user base has been stabilized in recent months. For Q1 2021, despite the impact from Chinese New Year, we expect our DAUs to be at a similar level as Q4 2020. And for full year 2021, we expect a modest user base expansion and also revenue growth for the entire company with improved user economics and overall profitability.

We are also very pleased to announce a new round of financing for Midu Novels in the amount of over $110 million. We will continue to be the controlling shareholder of Midu after the completion of the transaction.

We plan to use the proceeds to support the growth of the business across multiple fronts, from cooperation with strategic partners in field to higher-quality and original content to increase on the targeted user acquisition. We will, of course, continue to be disciplined with our spending, keeping ROI requirements high. We expect to double Midu's DAU as well as revenues by fourth quarter of 2021 based on our current budget and business plan.

Looking ahead, for the first quarter of 2021, we expect to further consolidate on the revenue base of Q4 2020 and generate revenues in the range of RMB1.250 billion to RMB1.300 billion. Despite the typical seasonality caused by the Chinese New Year, this showed a strong underlying trend in top line recovery.

We do expect to see a small non-GAAP operating loss for the group in Q1 2021 as a result of increased investment into content and user acquisition for Midu Novels. But excluding Midu, the rest of the company is expected to see a similar level of profitability as the last quarter. We are confident that after the strategic initiatives we successfully executed in 2020, which has put our business on a firmer and healthier footing, we will continue to build on our high-quality user base and higher monetization efficiency. We expect to grow our full year revenue from here and generate non-GAAP operating profit as well as positive operating cash flow for the entire group, including Midu in 2021.

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

Question-and-Answer Session

Operator

[Operator Instructions]. Your first question comes from the line of Vicky Wei of Citi.

Vicky Wei

Congratulation on the first profitable quarter. So my question is about Midu. So what does management think of long-term operating margin profile for the free online literature business in China?

And for Midu specifically in 2021, what is the specific user acquisition strategy as we see good user attrition from third-party database and what does it imply for the operating margin profile for Midu in 2021? And regarding to the first quarter guidance, what is the base case assumption for the revenue contribution of Midu?

Xiaolu Zhu

Thank you, Vicky. Regarding the long-term margin prospect of the Midu remodel, I think it's still too early as we are still in a relatively earlier stage of this business.

However, if you look at the overall group, the more mature part of our business, as we have already achieved like profitability in Q4 last year, we see that level to continue to increase for 2021. And I think overall, it's possible that we can achieve operating profit margin to be over 20%.

So Midu basically is in a similar process as we are also in an ad-supported business model. And without the loyalty points, I think Midu will be able to achieve at least a similar level of profitability over the longer term, which is over 20%.

The second question regarding our user acquisition strategy, as we have said during the prepared remarks that we plan to at least double Midu's DAU and revenue by Q4 2020 -- 2021 compared to a year ago. So I think for full year 2021, we will continue to invest in Midu throughout the year.

On the user acquisition side, as we have said before, that we want to be disciplined, we want to get the right ROI for all the marketing dollars we spent. And I think we will continue to see this approach as we have done in 2020. And so far, given the recovery of our revenue, especially on the Midu side, in terms of both revenue and ARPU, we think that we will be able to get very good ROIs in terms of our marketing program for 2021.

In terms of the revenue contribution and also margin impact for Midu, as I said, in Q4 last year, 2020, excluding Midu, the overall business, the rest of the company generated over RMB100 million in terms of operating profit. And for Q1, we expect the rest of the company to generate at least a similar level of operating profit.

So we do expect a small loss at the group level, mainly due to the increased investment for Midu. And I think this level of investment will continue throughout the rest of the year. Although given the recovery trend and then usually the low seasonality for Q1 due to Chinese New Year, we think that overall, the entire company will turn a profit for the full year 2021, which means that we will be profitable for the next three quarters, Q2 to Q4 in the remainder of the year.

Operator

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

Unidentified Analyst

Congratulations, management. I'm asking on behalf of Thomas. I got a question about the advertising industry. Could management comment on the competitive landscape of the advertising market since?

Xiaolu Zhu

Thank you. So I think we can mainly speak from our own perspective. So if we look back at year 2020, we took a balanced approach between profitability and growth. So we took a more disciplined approach to our investment, especially on the marketing side.

However, we do see trend of recovery, especially on the top line in the second half of 2020 -- of 2020, and I think this trend will continue in 2021. And we have seen very strong demand from our e-commerce partners in the second half of 2020. And app downloads and other web services, which is the top category for us in Q1 so far this year, is also gradually getting back as well.

We also have seen some recovery in terms of branding, which is another area that was weak in 2020. However, given our lack of exposure in this area in previous years, we have made some breakthroughs in 2020, and we think this will continue to contribute to our top line in 2021.

So overall, I think the landscape is gradually getting back. And we believe our strength in performance-based ads will help us to get through difficult times as our customers are increasingly looking for direct and more measurable results. So overall, I think we are quite confident in terms of the overall end market in 2021.

Operator

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

Sai Chi Du

Thank you all very much for joining us today, and thank you again for your time. If you have any further questions, please do not hesitate to contact us. Thank you, and have a good day. Thank you.

Operator

This concludes this conference call. You may now disconnect your lines. Thank you.