Pinduoduo Inc

NASDAQ:PDD

Earnings Call Transcript 2020-Q2

[Operator]

Hello, ladies and gentlemen. Welcome to Pinduoduo Second Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] Today’s conference call is being recorded.

I’d now like to turn the conference over to your speaker today, Mr. [indiscernible]. Thank you. Please go ahead.

[Unidentified Company Representative]

Thank you, Rachel. Hello, everyone, and thank you for joining us today. Pinduoduo’s earnings release was distributed earlier and is available on the IR website at investor.pinduoduo.com as well as through global newswire services.

On today’s call, our CEO, Chen Lei, will make some general remarks on our performance for the second quarter of 2020 and his primary areas of focus going forward. Our VP of Strategy, David Liu, will then elaborate further on our specific strategic initiatives. Last but not least, our VP of finance Jing Ma will take us through our financial results for the second quarter ended June 30, 2020.

Before we begin, I’d like to remind you that this conference contains forward-looking statements within the meaning of SECTION 21E of the U.S. Securities Exchange Act of 1934 as amended and as defined in the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements can be identified by terminologies such as will, anticipate and similar statements. Such statements are based upon management’s current expectations and current market operating conditions and relate to events that involve known or unknown risks, uncertainties and other factors, all of which are difficult to predict and many of which are beyond the company’s control, which may cause the company’s actual results, performance or achievements to differ materially from those in the forward-looking statements.

Further information regarding these and other risks, uncertainties or factors are included in the company’s filings with the U.S. Securities and Exchange Commission. The company does not undertake any obligation to update any forward-looking statements as a result of new information, future events or otherwise, except as required under applicable laws.

Now it is my pleasure to introduce our Chief Executive Officer, Chen Lei. Lei, please go ahead.

[Lei Chen, Chief Executive Officer and Director]

Hello, everyone. It's a pleasure to welcome all you to our second quarter 2020 results announcement. This is my first time communicating with investors around the world as CEO, even though I met many of you 2 years ago in our IPO Roadshow. It's great to reconnect and I look forward working together again and building ongoing dialogue.

I'm joined today by our Vice President of Strategy, David Liu and our Vice President of Finance Tony Ma. In the past [indiscernible] months, have been busy with management transition that was announced on July 1st. It was an evolving process that started 3 years ago, and the reason the decision was made with the full support of our Board.

We've always been thinking about how to create more opportunities to grow the next generation of leaders, how to keep this organization young, vibrant and at the same time increasingly institutionalized. This is especially important in our fast changing technology. We challenge ourselves continuously and incorporate fresh perspective so as to constantly satisfy and serve our users' needs. At the same time, we need to build a solid foundation for long-term and sustainable development of the organization.

Having built Pinduoduo into one of the bigger platforms in China and probably building numerous initiatives by the team during the pandemic, we feel the timing was right to pass on to our younger generation leaders more responsibility. Pinduoduo has grown at an extraordinary pace in the past 5 years. We are laser focused on our survival and growth. However, in the next few years, my goal is to translate this platform into a next level, one that is vibrant, innovative, energetic and institutionalized. The management and the Board hope to lay the strong foundation over the next few years to create a long lasting innovation and ecosystem that serve our society.

Colin has take a step back from the day to day management responsibility as a CEO, but he continues to be fully engaged and has been working closely with the Board and management to explore the company's future strategic process and organizational structure. Colin is also devoting more time to invest in and support foundational -- fundamental research in areas that become the future driver of our company such as agri-tech.

We believe this new division of labor allow Colin and I cooperate efficiently and steer the company in its next phase of growth and development. With over RMB1 trillion of GMV and 683 million annual active buyers, Pinduoduo is operating at significantly larger scale with much greater complexity today. We have demonstrated that our user centric strategy works. And we will continue to do what we do well to offer value for money products to our users through a fun and interactive experience.

As we continue to see significant potential for our platform, my priority as CEO are the various internal and external initiatives that we deem necessary to support and generate long-term sustainable values for our platform. Internally, it's important that we continue to make operational decisions efficiently, despite our growing number of business units and employees. I’m working with our team to leverage more technology to streamline internal processes and institutionalize the best practices. We are also focused on hiring the best talent and employing personnel development.

We continue to encourage mobility within our organization and motivate our to generate new ideas and compete for resources. Externally, we are going to increase strategic investment in our ecosystem, particularly in agricultural value chain. Our investment in the past 5 years has been primarily on our users via our sales and marketing expenses. And we have successfully build a very substantial user base of nearly 600 million in record time.

Our average daily parcel volume accounts for approximately 25% of China's daily parcel shipment. However, in terms of average spending per active buyers, we still see substantial upside potential. We will you continue to invest in building user engagement and make sure to grow our user frequency of purchases at average order value.

At the same time, we plan to pursue more strategic investment and partnership opportunities that will allow us to accelerate digitization of our supply chain and enhance efficiency and values that could be shared with our consumers. In particular, we started our business in agriculture and we plan to continue our focus in agriculture as our next strategic priority. Agriculture is a sector that touches largest number of people and yet has had the least amount of digitization in the past decade.

Any technology that can improve productivity and efficiency of an agricultural value chain will have a huge impact. Pinduoduo is already one of China's leading online distribution platforms for agricultural produce and agricultural products. We are uniquely positioned to drive trends in China's agriculture system. We combine consumer demand on our platform for create scale, and we can leverage consumer insights we gain to help farmers make more informed decisions across planting cycles, including what to plant and when to harvest.

We are prepared to invest in technology and operations across different parts of an agriculture value chain in order to assess the e-commerce penetration for the category and generate more value for both the farmers and the consumers. Our aim is to further consolidate our position as China's number one online agriculture platform and to build a worldwide presence in agriculture.

Let me now turn over to David to discuss some of our specific thoughts around agriculture.

[David Liu, Vice President-Strategy]

Thank you, Lei. One in four Chinese workers work in agriculture, but the industry makes them less than 10% of China's GDP. This is because agriculture has lagged behind other industries in digitization. Nearly 98% of farmers in China work on farms smaller than two hectares. It is difficult to standardize growing practices and achieve economies of scale. The rural workforce is aging and in decline as young people choose to work in the cities. The lack of coordination for food production makes farmers vulnerable to price swings, while wastage and high incremental distribution costs add to consumers' burden. Those are the challenges.

And the opportunity is that agricultural e-commerce can solve a number of these problems. Based on figures from the Ministry of Commerce, the implied total addressable market in 2019 for PBOC agricultural goods sales in China was RMB8.1 trillion, with less than 7% of these sales taking place online. In contrast, the online penetration for physical goods in total was 23% in 2019.

Pinduoduo is already one of the leading e-commerce platforms for agriculture. In 2019, we generated RMB136.4 billion or 13.6% of our GMV from agriculture produce and related goods. 1over 240 million or 38% of our annual active buyers purchased in this category last year, with a 70% repurchase rate.

Pinduoduo has become the go-to destination for high quality, great value aquaculture products. This recognition deepens through the pandemic. During 6.18, we saw orders for agriculture products grew 136% to RMB380 million. Nearly three quarters of the orders came from Tier 1 and Tier 2 city users.

We expect to continue gaining market share in agriculture and we see potential for our agriculture GMV to exceed RMB1 trillion in 5 years. Why do we think agriculture e-commerce can be tackled -- can tackle the challenges outlined earlier? Well, put simply, only when you digitize demand and supply, then can you drive efficiency and gains through the value chain in between.

Online retail has an advantage in terms of greater visibility. From production all the way to distribution, we have a unique position to make the value chain more efficient and bring more value to producers and consumers through investment and partnership that can also unlock commercial opportunities. Our vision is to realize the economic potential of China's vast agricultural resources by improving its overall quality and production efficiencies.

Starting with production, our efforts thus far have centered around the development of human capital through farmer training as well as initiation of pilot farms in our Duo Duo Farms program. Together with partner institutions such as China Agriculture University, we have been part of farming knowledge and business training to almost 90,000 new farmers thus far who tend to be younger and more digitally savvy. We see this initiative as a way to see a new generation of farmers who are more adaptive to new technologies.

Duo Duo Farms is a demonstration of how reorganizing resources through cooperatives and bringing our economic expertise can help farmers living in impoverished regions sustainably improve their productivity and household income. Duo Duo Farms serve as a test bed for us to introduce technologies to farmers such as drip irrigation, while also introducing changes to existing farming practices to drive meaningful change.

Building upon these experiences, we plan to invest in technology necessary to implement precision farming such as robotics, IoT sensors and low powered data transmission. Precision farming can help optimize inputs, better control diseases and reduce production costs. Our ongoing smart agriculture competition, jointly organized with the Agriculture University of China and with the support of the UN's Food and Agriculture Organization, exemplifies our interest to identify cost-efficient and scalable technology that can be promoted as standardized solution across China.

Global teams are competing over 14 weeks to remotely grow strawberries using sensors and machine learning algorithms. The objective is to drive the most cost efficient techniques to improve yield by integrating technology with traditional growing practices.

We also plan to further invest in and develop our proprietary agriculture analytics system by considering historical and projected data such as price, quantity, geographic distribution and logistical availability, the system will better advise farmers on which crops of higher economic value to plant, how to optimize quality over quantity, and how to achieve more timely distribution.

The system will also help refine our recommendations to consumers to reduce mismatch in supply and demand. Traditionally, agriculture produce go to at least five layers of distribution before reaching consumers. Industry research estimates as much as 105% added cost, 37% wastage across the chain for vegetables.

Pinduoduo team purchase model aggregates scattered interest into sizable coordinated demand and connect sellers directly with consumers to eliminate unnecessary costs. The next step is to find further -- is further optimize logistics for agriculture produce. From how it is packaged, handled and routed, there are hardly any cost effective specialized solution for agricultural produce today.

We plan to partner with logistics services providers to develop logistics dedicated to agriculture. As we can forecast demand by region, we can develop technology solutions with logistics partners to optimize delivery routes, coordinate delivery schedules, implement better quality service standards and optimize loading to and from the rural areas of China. We're also looking at advanced packaging solutions to offer our sellers and considering opportunities in warehousing technology and temperature controlled logistics.

We will also invest in technology for quality control and food safety. Unlike manufactured goods, it is more difficult to provide assurance on the quality and safety of agriculture produce. As consumers in China have become more health conscious, we expect more will be willing to pay a premium for quality and safety. We intend to address such needs through a combination of technology and certification backed by credible platforms.

We started collaborating this year with a research institution to develop a cost effective, robust method for testing fresh produce for contaminants like pesticides. We envision deploying such tests across a wide array of produce and at various points of the supply chain to provide greater assurance on food safety. We can offer such testing solutions and certification as value added services to our farmers and merchants. Certified products will receive preferential traffic support and command a premium from our users.

Our ability to differentiate such products would allow us to curate and price SKUs based on quality and recommend them to the relevant target users. With better quality products, it is equally or perhaps more important to invest in marketing to grow brand awareness. Take the French region of Champagne as an example. Sparkling wines made in Champagne are tightly regulated and must be made from a few prescribed [indiscernible] using traditional methods to ensure a consistent quality. Its sterling, rigorously defended reputation fuels consumers' willingness to pay a premium.

Similarly, in China, given its vast agricultural resources, we see opportunities to help create new brands for consistently high quality produce from the various geographic indications around the country. In fact, one of our Duo Duo Farm projects in Hunan is working to establish a nationally recognized destination for yacon grown there. To meet the destination, farmers will have to standardize and improve their farming practices. Farmers are incentivized to improve their practices in exchange for their products fetching a premium.

And we as a platform can provide more visibility to farmers on sales volume and pricing. We can help build awareness and promote origin stories to marketing, including virtual live streaming tours. The recognition of the quality provides further opportunity to develop related subindustries, from selling oranges to making marmalade and for selling peaches to validating eco tourism.

We see potential to work with farmers and distributors to develop branding for their produce and to address other value added opportunities, leveraging our consumer insights. While this may be a long journey, we are committed to invest in agriculture and agri-tech as that enables us to truly benefit all of our platform participants.

Now, let me pass it to Tony to discuss our financial results for the second quarter.

[Tony Ma Jing, VP of Finance]

Thank you, David. For the 12 months ended June 30, 2020, our GMV increased 79% to RMB1.27 trillion from RMB709 billion a year ago as a result of higher user engagement and increased spending per user. We report GMV on the same basis as other industry players to provide a meaningful comparison with that of our peers. The industry definition includes cancelled and returned orders. Comparing our GMV in Q2 versus Q1, the level of cancelled and returned orders has returned to normal historical level as China recovers from the pandemic.

Our average monthly active users in the second quarter increased by 81 million from the previous quarter to 569 million, or an increase of 55% from a year ago. Our annual active buyers for the 12 months ended June 30 grow 41% year-over-year to reach 683 million. This represents a net add of more than 200 million in the past 12 months.

The annual spending for active buyers in the 12 month period ended June 30, 2020 increased to 27% to RMB1,857 from RMB1,468 for the same period in 2019. The increase in annual spending per active buyer was moderated by significant number of new users added who contributed less than 12 months of purchases to our GMV.

During Q2, China's economy continued its recovery from the disruption caused by the pandemic. According to National Bureau of Statistics, online sales growth of physical goods accelerated in the second quarter, resulting in 14.3% increase for the 6 months ended June 30, 2020 from a year ago. This is up significantly from 5.9% growth for the 3-month period ending in March.

Consumer staples and household goods were significant growth contributors during this period. We observed a similar recovery trend on our platform. In Q2, our users had strong demand for household necessities and agricultural products and continue to be more selective and cautious on their discretionary spending. To address their needs, we expanded our promotion offering under the June 18 campaign to cover more household necessities, food and beverage products and agriculture produce.

We are continuing our efforts to provide compelling value in these categories together with China Consumer Association in early July.

Our total revenue in the June quarter were RMB12.2 billion, representing an increase of 67% from RMB7.3 billion in the same quarter last year. The increase was driven primarily by the strong momentum in online marketing services. Our online marketing services revenue grow 71% to RMB11.1 billion, and our transaction service revenue increased 38% to RMB1.1 billion.

We continued our support for certain SME merchants in Q2 by offering discounted transaction fees, but in general, observed a healthy recovery in merchant advertising activities. We benefited from merchants pent up demand and deferred marketing budget from the previous quarter. We also attribute high advertising activities to better merchant ROI due to higher user engagement on our platform and more compelling advertising products. The implied monetization rate, defined as total revenue divided by GMV for the last 12 months ended June 30, 2020 was 2.9% in line with the same period in 2019.

Now, moving on to costs. Our total cost of revenue this quarter increased to 67% from RMB1.6 billion in the same period last year to RMB2.7 billion this quarter, translating to a gross margin of 78%. Total cost of revenue increased mainly due to higher costs for cloud services, call centers and merchant support services.

Total operating expenses this quarter were RMB11.2 billion as compared to RMB7.2 billion in the same quarter in 2019. Our sales and marketing expenses this quarter increased 49% to RMB9.1 billion from RMB6.1 billion in the same quarter of 2019. On a non-GAAP basis, our sales and marketing expenses as a percentage of our revenue was 73% as compared to 81% for the same quarter last year.

We manage our sales and marketing spending dynamically based on expected ROI. Recognizing the fierce market dynamic in this year's 6.18 promotion events, we decided to moderate our investment during the second quarter. We continued with our 10 billion program and expanded our offerings to cover household staples that our users were looking for.

Looking ahead, we see significant potential to improve our users annual spending on our platform by building more user mind share and trust. We expect to continue our sales and marketing investment in the second half of 2020 to drive more user engagement. We will continue to spend whenever we see attractive opportunities that meet our internal ROI hurdles.

General and administrative expenses were RMB395 million, an increase of 42% from RMB278 million in the same quarter of 2019, primarily due to an increase in headcount. On a non-GAAP basis, our G&A expenses as a percentage of our revenue was 1.1% in Q2. Research and development expenses were RMB1.7 billion, an increase of 107% from RMB804 million in the same quarter of 2019. The increase was primarily due to an increase in headcount and the recruitment of more experienced R&D personnel, and an increase in R&D related cloud service expenses.

On a non-GAAP basis, our R&D expenses as a percentage of our revenues was 10.4% in Q2. Technology is fundamental to our operations, and we plan to increase our spending on engineering talent and technological capabilities going forward. Some of our key R&D initiatives include developing our demand forecasting system for agriculture, database for C2M manufacturers and the logistics planning system.

As a result, our operating loss for the quarter was RMB1.6 billion on a GAAP basis compared with operating loss of RMB1.5 billion in the same quarter of 2019. Non-GAAP operating loss for the quarter was RMB725 million compared with RMB898 million in the same quarter of 2019.

For the quarter ended June 30, 2020, we recorded net operating income of RMB740 million compared with RMB487 million in the same quarter in 2019. The increase primarily reflects the net impact of higher interest income, interest expenses from amortization of our outstanding convertible bonds and the gain on fair market value change from long-term investments. We excluded the later two items in addition to share-based compensation in our presentation of non-GAAP metrics.

To sum up, our net loss attributable to ordinary shareholders was RMB899 million on a GAAP basis as compared to a net loss of RMB1 billion in the same quarter of 2019. Basic and diluted net loss per ADS was RMB0.75 on a GAAP basis compared with RMB0.88 in the same quarter of 2019. Non-GAAP net loss attributable to ordinary shareholders was RMB77 million compared with RMB411 million in the same quarter last year. Non-GAAP basic and diluted net loss per ADS were RMB0.06 compared with RMB0.36 in the same quarter of 2019. That completes the profit and loss statement for the second quarter.

Now on the cash flow. Our net cash flow generated by operating activities was RMB5.5 billion, as compared to RMB4.1 billion in the same quarter of 2019, primarily due to an increase in online marketing service revenues. As of June 30, 2020, the company's cash reserve comprising of cash, cash equivalents and short-term investments was RMB49 billion as compared to RMB41.1 billion at the end of December 2019. We allocated most of our cash reserves to highly liquid short-term investment to receive better cash yield and to maintain flexibility to withdraw and deploy capital strategically as necessary.

Finally, let me touch on the ongoing development in the U.S to prohibit foreign insurers' access to U.S capital market if sufficient audit access cannot be provided to the U.S Public Company Accounting Oversight Board. On August 6, the President's Working Group on Financial Market released its report recommending SEC to implement rules that would require issuers to grant PCAOB access to work papers of the principal audit firm in order to maintain listing by January 1, 2022.

The recommendations also provide an option for companies to provide a core audit from an audit firm that meets PCAOB's inspection requirements. The administration's recommendation, if adopted, would still require SEC to design and put in place detailed implementation rules. We continue to monitor the situation closely and are prepared to work with relevant regulators in China and the U.S to address these concerns when there's more clarity.

We completed our SOX internal control audit for 2019 with no material deficiency identified. We are confident of the quality of our disclosure and the financial reporting, and we are committed to continuing our efforts to provide a high degree of integrity in our accounting. This concludes our prepared remarks.

Operator, we're ready for questions.

[Operator]

[Operator Instructions] Your first question comes from the line -- [Operator Instructions] Your first question comes from the line of the Gregory Zhao of Barclays. Please ask your question. Mr. Gregory Zhao, your line is now open.

[Gregory Zhao, Barclays]

Sorry, I was mute. So thanks for taking my question. So we saw PDD made some efforts to move to the high-end market and started to sell some luxury products, including Tesla cars. So I just want to understand a bit more about how this will help you improve the ARPU and help you to get expanded into the high-end market? A quick on the year-over-year growth of the GMV growth. So we know last year was the first time you joined the 6.18 promotion season. So how shall we think about the relatively high base, the impact to your 2quarter GMV growth? Thank you.

[David Liu, Vice President-Strategy]

Gregory, thanks for the question. Let me take your first question around brands and products. Our products and brand strategy is actually oriented around giving users what they want and serving them well. So it is not our intention to build or engaging in the type of promotion that you have seen. The intention is not to drive our AOV. The aim is actually to build Pinduoduo into a destination for quality, authentic and value for money product across categories and price points. So we are continuing to grow the depth and breadth of SKU across the platform, whether they are branded or unbranded. In fact, as I highlighted in my comments earlier, we are highlighting agriculture as a product category where we think we can strategically add a lot of value over the next few years by investing in our supply chain and making available higher quality and better product for our users.

And with regard to your question on GMV, first of all, I would like to just remind the audience that comparing GMV growth in the second quarter versus the first quarter is meaningful because of the impact of the pandemic. In fact, we are very pleased with our GMV growth this quarter, and particularly in the context of having added a 100 million of active buyers since the beginning of this year. Our focus as a company this year in terms of our strategy is to continue to invest in user engagement and to build our mindshare because as you look at the scale of the user base we have accumulated, 683 million active buyers, we believe that what we need to do is continue to improve our engagement with them and to grow their mindshare.

The GMV for the second quarter are impacted. I will also note that changes in consumer spending, we saw a pickup in consumer activity since the first quarter as the economy recovered. However, we did notice that consumer spending was much more value conscious and consumers are looking for more household necessities such as FMCGs and agriculture produce among our platform. So as you saw in our 6.18 campaign, we actually expanded our coverage in the campaign to cover more products in these categories, and we are continuing to support the consumers in these efforts.

[Gregory Zhao, Barclays]

Okay, thank you.

[Operator]

Your next question comes from the line of Piyush Mubayi of Goldman Sachs. Please ask the question.

[Piyush Mubayi, Goldman Sachs (Asia) LLC]

Thank you for taking my question. May I just ask a couple of details of how the transaction commission revenues, marketing services revenues are progressing and how that take rate has evolved? Your marketing service sector seems to have gone up to 3.2% in the quarter, which is a huge improvement year-on-year on any other metric, probably the highest ever. Should we then think of that as the number that we can expect for you to continue to maintain in the future? And also, when you look at the growth rates in transaction commissions, which was 76% in 1Q, that's slowed down to 38%. Is there anything there that's different that would lead us -- lead to that slower growth rate? And in the similar manner, the marketing services revenue, which is at 71%, is meaningfully higher than the pace of growth that you're seeing in the GMV for the quarter. So if you could just take us through what's going on there. Then I have a few questions in agriculture, if I might. Thank you.

[Tony Ma Jing, VP of Finance]

Okay. Let me take this one, then. We do saw a stronger-than-expected recovery in merchants advertising in Q2. Our merchant had more budget to spend, given limited activities in Q1, and they were eager to make up for their loss in Q1, and higher user activities and advertising also helped to improve the advertising returns. Our higher take rate in Q2 reflects the supply demand dynamic post to the pandemic actually. The level of returned and unpaid order also return to the normal level. If we take together our Q1 and Q2 number as an aggregate level, the takeaway for the first half of the year actually is 2.9% in line with our historical results. Takeaway for us, it's an output, not an KPI we try to optimize. Our priority is on our user engagement. With stronger user engagement, merchants would naturally want to advertise more. We will continue to support good quality merchants and incentivize them to improve the service and provide better value to our users.

And regarding the second question or the question on the transaction service revenue, the transaction service revenue comprised primarily of what we previously termed commission fees, the payment process fees, which we charge as a standard rec rate of 0.6%. However, we continue to offer a preferential rate for certain merchants as incentive.

[Piyush Mubayi, Goldman Sachs (Asia) LLC]

And may I just ask a follow-up question? Just wanted to understand where -- what percentage of the GMV today is agriculture, or say, for the second quarter? And when you talk about RMB1 trillion 5 years out, we presume that's about 15% to 20% of GMV at that point of time, would that be the right mix to think through for agriculture? And if you could just give us a feel for what sort of take rate that we could earn from the business. Would it be commensurate to or comparable to the 3.2%, for example, that you’ve shown us in Q2, 5 years down the line, I mean. Thank you.

[David Liu, Vice President-Strategy]

Piyush, thank you for that. Let me just also add a little bit to context around the take rate. As we have communicated to the market previously, the take rate really is an output. It's a function of the merchants advertising on our platform and seeing the right levels of return. So we actually saw in the second quarter very strong merchant activities as merchants tried to some more -- move on inventories and goods in the second quarter. And as a result, we saw very strong advertising demand, which we think actually contributed to that take rate. Similarly, I would note that on our platform, we are seeing advertising activities really across the board from many different sectors. So it is in particular categories per say.

And similarly, we do believe they are potentials in agriculture merchants, I mean, distributors to contribute to advertising as long as they are able to actually offer the type of premium product that allows them to generate the type of return. So while we are seeing this, given the low e-commerce penetration rate in agriculture, we actually see substantial opportunity for us to invest in our supply chain and to drive more value creation down the road. So, yes, we do believe that certainly generating a type of return commensurate with what the platform is generating today is possible in agriculture. But that may come in the form of both advertising and also us providing technology solutions to the participants in our ecosystem.

[Piyush Mubayi, Goldman Sachs (Asia) LLC]

Thank you.

[Operator]

Your next question comes from the line of Alicia Yap of Citigroup. Please ask your question.

[Alicia Yap, Citigroup Global Markets Asia]

Hi. Good evening, management. Thanks for taking my questions. I have a question related to more medium longer term. So how will PDD attract broader varieties of merchants and brands to join the platform when you indeed now have a larger base of merchants, and then you also have -- that your user base also reaching quite large number. So how do you balance and ensure all the merchants will receive the relevant exposure? And what does PDD need to do to serve this broader range of the merchants? And how will the team purchase model evolve if we get more branded products or branded merchants on our platform? Thank you.

[David Liu, Vice President-Strategy]

Thank you, Alicia. Our strategy around branded products and brands has not changed. In fact, as I mentioned earlier today, the idea is to continue to focus on providing what the users want. So from that perspective. What we are seeing is the team purchase model working, and this is the reason why we have been able to accumulate 700 million users, it was in such a short period of time. And this continues to work because we are a recommendation based business model focusing on specific SKUs as opposed on brands, right? So we do believe that as everyone's demand on the platform really ranges across different price points for different categories. And through -- as we continue to get better, our recommendation, we understand the users better, we are able to push them the most relevant products at the most relevant price points. And as the user activities and user engagement grows, the merchants naturally are coming to our platform, seeking for growth and more opportunities. And the merchants themselves would be able to get the right level of traffic if they are able to offer the right value for their customer base. So what we are doing is through the algorithms and through our recommendation, working with the merchants to help them provide more suitable products that are targeted at the users. And we believe the algorithm is working and continuing over time, our recommendation will get better. And through a combination of offering the right product and also advertising on the platform, we believe the merchants will continue to see the attractive returns on their investments.

[Alicia Yap, Citigroup Global Markets Asia]

I see. Okay, thank you.

[Operator]

The next question comes from the line of Thomas Chong of Jefferies. Please ask your question.

[Thomas Chong, Jefferies Hong Kong Limited]

Hi. Thanks management for taking my questions. My question is about the business momentum in July and August across different product categories? Thanks.

[David Liu, Vice President-Strategy]

Sorry, Thomas.

[Tony Ma Jing, VP of Finance]

Hey, Thomas, is the question around our strategy or the trends we're seeing across different categories?

[David Liu, Vice President-Strategy]

Operator, maybe we can take the next question first before we take Thomas back.

[Operator]

Certainly. Your next question comes from the line of Tina Long of Credit Suisse. Please ask your question.

[Tina Long, Credit Suisse]

Hi, management. Thank you for taking my questions. I have two questions. The first one is on the sales marketing because in your prepared remarks, you mentioned that you intentionally moderate the sales and marketing spending due to, I think, probably peers actually have been pretty aggressive. And also, you expanded the RMB10 billion program to some [indiscernible]. So I want to know in the next two quarters, third quarter and fourth quarter, what are the plans for your sales and marketing and under what circumstances you actually set up the sales and marketing? That's the first question. I'll do the second one after this. Thank you.

[David Liu, Vice President-Strategy]

Sure, Tina. Let me ask Tony to address the question.

[Tony Ma Jing, VP of Finance]

First of all, the Q2 on sales and marketing expenses, we say to moderate our sales and marketing spending is when we observe this aggressive promotion spending by our peers on electronics. Relative to that, we saw household goods as more attractive opportunity to advance user engagement. Therefore, household goods has -- actually has a higher purchase frequency than electronics. So we choose a different strategy to investing in Q2. We actually plan to deepen our user engagement going forward so that we will continue to spend on sales and marketing in the coming quarters to grow the mindshare and trust among our users. We expect to increase our sales and marketing investment in the second half of 2020 in a prudent manner as well as we spend whenever we see opportunity meets our internal ROI hurdles.

[Tina Long, Credit Suisse]

Got it.

[Tony Ma Jing, VP of Finance]

Our annual spending per active user are still -- lags behind our peers. We believe we can narrow that difference by growing our mindshare with users and -- to get more wallet share, that's why we have to continue this type of investment.

[Tina Long, Credit Suisse]

Okay, thank you, Tony. Yes, my first question is sort of related to this, because I think based on the public data, the actual volume is actually very strong from PDD, so -- but the GMV actually was sort of lower. So does that imply the average order size, is actually trending down? Can you share a little bit more about the average order size and also outlook? Because if you continue to allocate more traffic to the household goods, so will we continue to see the average order size to be -- to stay at low level? Thank you.

[Tony Ma Jing, VP of Finance]

Let me take this. Users tends to associate Pinduoduo as their go-to platform for great savings every day. So for us, we also tend to have a less of concentrated spike in GMV and user activities around shopping promotions unlike how we use this -- our peers. Our user engagement tends to trend in a steady fashion and reflective -- which reflective of our gain in building our mind share. And we will continue to invest in the user mind share to build on high frequency of engagement. In fact, that's what we did in Q2. We noticed the consumer spending was more value cautious and the consumer were looking for more household necessities, including FMCG, agriculture produce. That's why we dedicated our promotional programs during the June 18 to include more products in these categories. This definitely have an impact on the AOV. Also, we add almost 100 million active buyers since beginning of this year and these users are just getting to know Pinduoduo, and actually their contribution to the GMV is less than 12 months. Also, they are still developing their spending behavior on our platform.

[Tina Long, Credit Suisse]

Okay. So does that mean the outlook of AOV will stay at a lower level for a longer period of time?

[David Liu, Vice President-Strategy]

Tina, so what we have seen in the second quarter is growth across the categories. But as I mentioned, the consumer behaviors in the second quarter were more value conscious and we adapted the marketing strategy accordingly. So we do believe that, Pinduoduo -- many users associate Pinduoduo as a platform where they would go for great value product, and we have seen people coming to us in the second quarter, particularly looking for that -- for those products. We find these product categories to be quite compelling in a sense, because they have a high frequency, high engagement. And we do believe that over time the AOV will continue to grow as they build their shopping behavior, their spending behavior on our platform over time.

[Tina Long, Credit Suisse]

Okay, got it. Thank you very much.

[Operator]

Your next question comes from Thomas Chong of Jefferies. Please ask your question.

[Thomas Chiong]

Hi. Good evening. Thanks management for taking my questions. Can you comment about the livestreaming online shopping strategies? Thank you.

[David Liu, Vice President-Strategy]

Thomas, in terms of livestreaming, we have seen continuing adoption of our merchants using the livestreaming as a feature to create engagement with their consumers on our platform. However, we do not position or do not consider livestreaming to be a separate marketing tool. We consider really as part of the integrated experience on our platform. So -- also Pinduoduo, as you will note, that we don't have actually a dedicated channel of entrance for livestreaming. Instead, you actually are -- our users come in contact or come in access to the livestreaming road [ph] through their browsing experiences as they explore their SKUs, they will notice that this particular SKU may be in a livestreaming and they will click into livestreaming and view the product being introduced. And in that context, they may choose to purchase or they may choose to bookmark the seller, or actually they may have seen something through their browsing next time they end up purchasing. So we do and we position intentionally livestreaming to be part of the holistic experiences that our merchant can offer to our users and begin to add to that exploration -- exploratory experiences our users have on the platform.

[Lei Chen, Chief Executive Officer and Director]

Yes, one more thing I'd like to add is livestreaming will be one of the key demands our customers post -- in this year. And actually there are many others and we try to have a full [indiscernible] understanding about our customers, and we actually have more than just one features, try to capture different kind of needs -- different kind of demand our customer has had since the starting of this year. So I believe that livestreaming just is one of them, but not all of them.

[Thomas Chiong]

Thank you.

[Lei Chen, Chief Executive Officer and Director]

Thank you, Thomas. Operator, next question, please.

[Operator]

Your last question comes from the line of Binnie Wong of HSBC. Please ask your question.

[Binnie Wai Yan Wong]

Hi. Good evening, management. Congrats on a strong improvement in the bottom line. I’ve two questions here. First question is on the monetization rate. It's true that -- I mean, the second quarter, the monetization rate sharply increased to 3.2%. But if we look at on a half year basis, right, there's only -- that’s around 2.5%, which is just similar to what we have done in the past years. So should we just think of it this is more about a rise in spending from the pent up demand? Or should we think about second quarter as there's some structural positive drivers that can last into the second half of the year, so just directionally thinking about it. And then following on, on that is that if you’re thinking about the rising online marketing from which pool -- which advertising category. Is it because there we also do more -- management said about the agricultural advertiser and FMCG. Do they tend to see bigger ad spending? Like do they have a bigger ad pocket? Thank you. And I just have a quick follow-up. Thank you.

[Lei Chen, Chief Executive Officer and Director]

Hey, Binnie, thank you for the question. Your question around the take rates, I would say that and as -- I would say that take rate itself really is a function of merchant investing or pay -- and buying advertising to generate return for their sales. And as many of you have noted in your interviews with merchants, the advertising return on our platform are better than that relative to our peers. So it is I would consider -- I urge you to consider the advertising spend from merchants from that perspective. Of course, it is true that because in the first quarter, the merchants weren’t in a position to spend their advertising budget. So we did benefit from some of that pent up demand. But our conviction is that as long as we continue to deliver better or solid attractive advertising return to the merchants, they will continue to advertise. So we're doing this both in terms of improving our recommendation algorithm, but also improving better advertising products.

So as an example, we rolled out at the end of last year product that helps -- a smart tool that helps merchants to optimize their advertising return, as an example. So many of the merchants on platform may not be as savvy and they don't really understand how to optimize for keywords or for banner ads. However, by using our automated system, they at least are guaranteed a minimum threshold return, so they are in a better position and more willing to spend. So we do think that part of that -- pickup has to do with the better advertising products that we are providing. And also, of course, you cannot do this without a very, very active user. So as I mentioned on our call, our strategy this year is to continue to invest in user engagement. And with user engagement we believe the return to merchants advertising will continue to be attractive and they will continue to have that demand over time.

As to your question specifically around advertising tools, as you know, we started our business -- advertising business in -- primarily in search. But as our business model focuses on recommendation, we have seen pickup and we expect to continue to see pickup, see advertising as a contributor to the online marketing services revenue.

[Binnie Wai Yan Wong]

Okay. Thank you so much. And just a quick question here is that is -- I mean, it's a very good quarter that we see the operating margin is historically the narrowest in terms of the losses. It's a significant improvement in the operating margin side. Do you think this is something that we can extrapolate because of this efficiency and we reached kind of like an equilibrium as to how much we spend and then how much we can grow our top line? Or is it that we should expect some quarterly fluctuation? Because I do understand sales and marketing is -- that’s quite impacted by seasonality. So should we think about this to extrapolate into the second half? And is there something that is kind of like we wish this inflection point already? Thank you.

[Lei Chen, Chief Executive Officer and Director]

Yes, I think you're talking about the profitability question here.

[Binnie Wai Yan Wong]

Yes. That’s right.

[Lei Chen, Chief Executive Officer and Director]

Our Q2 results do demonstrate how leverageable our business model is and how we could deliver profitability in the short-term. But we don't believe it is the right strategy to focus on the short-term profit over a sustainable long-term value. Our vision is to offer value for money products to all users through fun and interactive shopping experience. We still need to continue our investment to grow user mind share and engagement, as we mentioned several times in the prepared remarks. So we are not considering profitability this year.

[Binnie Wai Yan Wong]

Okay.

[Lei Chen, Chief Executive Officer and Director]

Actually we also plan to step up our investment in our ecosystem through strategic partnership and capital investment to better support our merchant in offering better value and better service to our users.

[Binnie Wai Yan Wong]

Okay. Thank you. That’s very clear, super clear. Thank you so much.

[Lei Chen, Chief Executive Officer and Director]

Thank you.

[David Liu, Vice President-Strategy]

Thank you, Binnie.

[Operator]

I would not like to hand the conference back to the presenters for their closing remarks. Please go ahead.

[Unidentified Company Representative]

Thanks, operator. Thanks, everyone, for joining us on the conference call today. If you have any further follow-up questions, please feel free to reach out to the IR team. We are always here for you. Thank you and have a good weekend.

[Operator]

Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may now all disconnect.