Pinduoduo Inc

NASDAQ:PDD

Earnings Call Transcript 2018-Q3

[Operator]

Ladies and gentlemen, thank you for standing by and welcome to the Pinduoduo Third Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. [Operator Instructions] I must advise you that this conference call is being recorded today, 20th of November 2018.

I would now like to hand the conference over to our first speaker today, Mr. Christian Arnell. Thank you. Please go ahead, sir.

[Christian Arnell, Investor Relations]

Thank you, operator. Hello, everyone, and thank you for joining us today. Pinduoduo's earnings release was distributed earlier today and is available on our IR website at investor.pinduoduo.com, as well as through Globe Newswire services.

On the call today from Pinduoduo are Mr. Zheng Huang, Chairman and Chief Executive Officer; and Mr. Tian Xu, Vice President of Finance. Mr. Huang will review business operations and company highlights, followed by Mr. Xu, who will discuss financials. They will be available to answer your questions during the Q&A session that follows.

Before we begin, I'd like to remind you that this conference contains forward-looking statements made within the meaning of Section 21E of the 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 terminology such as will, expect, anticipate, future, intend, plans, believes, estimates, targets, going forward, outlook 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 is 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 statement as a result of new information, future events or otherwise, except as required under applicable law.

It is now my pleasure to introduce Chairman and Chief Executive Officer, Mr. Huang. Mr. Huang, please go ahead.

[Zheng Huang, Chairman and Chief Executive Officer]

Thank you, Christian, and thanks everyone for joining us on our third quarter results discussion. We just released our third quarter results. Our last 12 months GMV grew 386% year-over-year to RMB344.8 billion. This was fueled by the growth in our annual active buyers, which more than doubled, and further compounded by doubling in the annual spent per active buyer. Over the last 12 months, we had 386 million users make at least one purchase on our platform, an increase of 42 million users over the prior quarter. During the third quarter, we had an average of 232 million MAUs, an increase of 37 million users over the prior quarter this year.

Our revenue for the third quarter grew almost 7x over the same period in 2017 to RMB3.4 billion, primarily driven by the growth in our online marketing services, which we have only launched in April 2017. Though our monetization rate continued to improve, it was partially offset by the strategy we announced in last quarter after rewarding higher quality merchants with more traffic. We hope to create a virtuous cycle whereby high quality merchants who will provide a value for money products with good user experiences are rewarded attracting more high quality merchants to our platform.

At Pinduoduo, user satisfaction is our ultimate goal. We have created a platform where users can discover value for money products in a fun, social and entertaining setting. By aggregating the demand for each SKU into larger volumes through our team purchase option, we enable our merchants to better manage their supply chain and lower their production and logistics costs. The savings can then be transferred to our users. Therefore, users often find products at a cheaper price they expected as compared to their perceived value of those products.

We are very focused on improving efficiency and capabilities of our merchants so that we can serve our users better. Over the last 30 years, China has grown to become the largest manufacturing base for most consumer goods sold worldwide. However, it also has a complex distribution system. The average manufacturer lacks a good understanding of the consumers and doesn't have much visibility on the demand for their goods. As such, manufacturers may lose out on potential sales if their products are expectedly popular or they may end up having to discount deeply to move inventory if they overproduce.

Our platform aims to let the manufacturers have a more direct pulse and the consumer demand. We hope that as our technology advances, our team purchase option put into only help aggregate demand quickly but also be able to assimilate the likely demand at a certain point in time, and then relay this information to manufacturers. By equipping merchants with the data analytics, they then have ample lead-time to make adjustments and prepare the products for shipping. Over time, based on our data, the merchants can also develop particular SKUs that are better suit to their target consumer taste and by cutting out the middleman manufacturers retain more profits, while our users get better quality and value for money products. Linking the users to manufacturers in this way reduces waste and will allow manufacturers to build strong original brands over the long run.

This is important as we have also observed that younger consumers increasingly prefer more personalized offerings that are tailored to their need. The supply chain therefore has to evolve in order to cater to this demand for personalization. The next step in this evolution is the utilization of 5G, IoT and AI. As 5G rolls out at a scale and adoption grows, the industrial supply chain will also be transformed as data flows and information exchange happens on a much faster level. Whether it'd be a tree in orchids or a batch of raw materials in the factory, all of the information about different parts of the supply chain can be readily grasped. At the same time, as the vast amounts of information gets processed that it paves the way for innovative new technologies, one of the industries that it can be really transformed by this is agriculture.

Most of the agricultural land in China has scattered through small-scale farming. Unlike farming in U.S., which is more standardized, Chinese farmers often lack basic information on market demand, which means they face uncertainties throughout the farming cycle. For example, what to plant, how much would sell and how much what it is sell for? Making matters worse is convoluted distribution structure between farmers and the consumers resulting in a spoilage and limited shelf time by the time the product to reach its consumers. Farmers operating under this traditional structure are often forced to harvest their produce prematurely or to build their produce in chemicals in order to prolong shelf time, consumers end up paying not only a higher price, but gather inferior product.

Our solution today is to aggregate the demand of consumers through our team purchase option and a channel that is sizable demand to farmers. With more market intelligence and transparent commodity pricing, farmers can set their own price, compare their price with nationwide peers, and then work on how to market their products to users with a right price point and packaging. Thereafter, they can ship the product directly to the 384 million users on our platform. While the existing logistics infrastructure in China is not a well-suited before delivering fresh produce, there is at least a basic network that farmers can tap on to reach consumers.

Consumers end up getting fresher and safer products for better price, while farmers schedule to make more money, which can be reinvested to improve their farming practices and a set of both their production for quantity and quality. This creates a win-win outcome, and it can have great impact on transforming agriculture and uplifting the poor, as an example, in [indiscernible] county in [indiscernible] which is mountain and its difficult to getting into. There is often excess inventory of their locally produced oranges. At times, farmers cannot even sell their oranges for $0.60 a kilogram, which is a shame as these are high quality oranges.

Now, with on-boarding of their produce on our platform, the farmers can realize as stable selling price of RMB6 a kilogram. By year-end, the [indiscernible] county will cross the national poverty line. This is just one example out of the 730 impoverished counties we are working with. But it shows the real impact that technology can have and how we can do our part to uplift to the poor. Going forward, we will continue our efforts to aim farmers in impoverished countries. What we have achieved so far is just the first step and we look forward to contributing more.

Next, I would like to take this opportunity to update you our effort to fight, compensate and infringing products on our platform. From the very beginning, we were the first platform in China to strictly hold all our merchants to the standard of our 10x penalty on counterfeit goods. After 50 odd brands, we were alleged to have counterfeit or infringing versions on our platform. We have thoroughly investigated over the past few months and found that plenty of these "fake brands" never existed on our platform. Of the other 30, we have finished our cleaning efforts and have worked tirelessly to close every loophole and tackle all issues. Additionally, we set up reach our public comps to clarify any residue buyer concerns.

Since August, we have also upgraded our merchants' on-boarding system to integrate with the police identity verification system from the consumer end. We have refreshed our search algorithm to diploid the legitimacy brand name even we have user's key in infringing brands. By striking at a root and removing incentive for copyright infringement, we hope to weed out bad behaviors.

We will continue to invest in our technical capabilities associated to keyword identification, filtering image, tax and video imaging recognition and developing a blacklisting mechanism. We are also creating a fast-track IP channel with the government to have merchants apply for their own trademarks and build their own brands. At the same time, we continue to collaborate closely with the authorities to uphold the rights of consumers.

We are grateful for all the parties that have made us a better perform throughout this process, especially the government, which has been extremely supportive and understanding, the media, which has helped us uncover cases of abuse, and users who have trusted us and helped us with their candid reviews on our platform.

All of the above wouldn't have been possible without our focus on technology. As we continue to grow in size and build out our offering to our users, we plan to invest more in our efforts in R&D and also upgrade our existing infrastructure to meet future demand. We continue to improve the accuracy of our product recommendations and add targeting by enhancing our distributed AI infrastructure. We are also in discussions with various institutions worldwide to partner our initiative to further our technical knowhow around distributed AI to help ourselves better understand our user behavior and to enhance user data privacy protection capabilities. I myself will be leading this effort and we hope to share our results with the public at a later stage.

Finally, to end on a more lighthearted note, let's talk about Duo Duo Orchard, which I mentioned last quarter. Duo Duo Orchard is a game that rewards users for completing a variety of emissions daily as they try to grow virtual fruit trees. Once the user achieved bear fruit, we send an actual package of fruit to them as a reward. Participation on Duo Duo Orchard is so strong that we now send out over 500 tons of fruit daily from farmers in impoverished areas like southern Xinjiang.

Duo Duo Orchard allows us to delight our users while doing good and encapsulates our company division of offering the users a differentiated and entertaining shopping experience with value for money products. Last month, we celebrated the third year anniversary of our app with our users, merchants and employees. We're grateful for all our ecosystem partners as well as all experienced investors worldwide who have supported us. We see ourselves as a very young company with much room for further improvement and we will dedicate ourselves relentlessly to meeting our users' needs and overcoming all obstacles along the way.

With that, I will hand the call over to our VP of Finance Tian to walk through our financial results in the quarter. Tian, please.

[Tian Xu, Vice President of Finance]

Thank you, Colin. Hello, everyone. Or total revenue in this third quarter were RMB3.4 billion, growing strongly by 697% from RMB423 million in the same quarter last year. The main driver of this growth was our online marketing services. 88% of the total revenue or RMB3.0 billion were revenues from online marketing services, which increased significantly from RMB290 million during the same period last year, and 25% from the prior quarter. The increase was due to our increased number of users and the growing user engagement, which supported our healthy GMV growth and demand for advertising on our platform. 12% of our total revenues or RMB398 million, were revenues from commission fees, which increased from RMB134 million during the same period last year and 80% from the prior quarters. That increase was driven by the gross in our GMV.

We continue to keep our commission rates low and offer some discounts to selected merchants. Our low fees structure combined with our ability to aggregate large volumes of orders for merchants has made us an attractive platform for merchants. As we grow our buyer base and the breadth of our products selection, we are confident that it will also increase the annual average spending per user, which, as you have seen, has been doubling year-on-year over the last three quarters.

You may also recall on last quarter we talk about rewarding high-quality merchants to create a virtuous circle and weed out the less compliant merchants. Specifically, we have offered the more traffic with better pricing and discounted commission fees to those high-quality merchants. This has strengthened the growth in our monetization rate in the short-term, but we believe this is the right thing to do as we strive to deliver the best customer experience. We are pleased with the results of our strategy so far and remain deeply committed to improving our platform.

Moving on to costs. Total cost of revenue increased by 315% year-over-year to RMB775 million from RMB187 million in the same quarter of 2017. The increase was due to higher costs for cloud services, our call center and merchant support. Total operating expenses were RMB3.9 billion compared with RMB471 million in the same quarter of 2017.

In particular, sales and the marketing expenses came in at RMB3.2 billion, mainly due to an increase in branding campaigns and online and offline advertisement and promotions. As we continue to invest in strengthening our brand recognition and facilitating greater user's engagement, the momentum seen in our MAU growth this quarter evidenced to a degree that the investments in marketing we have made in the past quarters is effective and will continue to payoff in the long term.

General and administrative expenses were RMB306 million. The increase was primarily due to an increase in headcount. Research and development expenses rose to RMB332 million, primarily due to an increase in headcount and the recruitments of very experienced research and development personnel, as well as an increase in our R&D-related cloud services expenses.

As shared by Colin, we continue to focus on expanding our technological capabilities for the long-term growth of our platform and expected our R&D expenses to grow further. We are in active discussions to launch research initiatives to help us improve our platform and the services. Operating loss was RMB1.3 billion compared with the loss of RMB234 million in the same quarter of last year. Non-GAAP operating loss was RMB790 million, an increase from RMB231 million during the same period last year.

In the third quarter, net loss attributable to ordinary shareholders was RMB1.1 billion compared with the loss of RMB221 million in the same quarter of last year. Basic and diluted net loss per ADS was RMB1.20 compared with RMB0.52 during the same period of last year. Non-GAAP net loss attributable to ordinary shareholders rose to RMB690 million compared with RMB218 million in the same quarter last year. Non-GAAP basic and diluted net loss per ADS were RMB0.68 compared with RMB0.48 for the same period of 2017. That completes the profit and loss statement for the quarter.

Net cash flow provided by operating activities was RMB250 million compared with RMB682 million in the same quarter last year, primarily due to an increase in our online marketing services revenue. As of September 30, 2018, the company has a strong balance sheet with RMB15 billion in cash and cash equivalents, an increased from RMB3.1 billion as of December 31st 2017. It is primarily from our IPO proceeds. On top of our cash balances, we also have another RMB7.5 billion of short-term investment. Altogether, we have RMB22.5 billion of cash and short-term investments.

Our strong balance sheet and healthy operating cash flow highlights once again the extremely cash flow generated business model that we have and provided us with a good cushion to make the necessary investments to grow our business.

Lastly, I would like to make a quick comment in response to claim that the company has misrepresented our revenues and earnings. I would to stress that we have always held ourselves to the highest standards and that the numbers in our consolidated financial statements are in compliance with the rules and regulations of the SEC.

Our filings are in accordance with U.S. GAAP and the audited financial statements included therein, have been audited by Ernst and Young. Similarly, our related party transactions, as included in the IPO prospectus, have also been disclosed in accordance with the U.S. securities laws, listing rules and NASDAQ regulations.

This concludes our prepared remarks. Operator, we're now ready to begin the Q&A session. Thanks.

[Operator]

Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] So we have the first question coming from the line of Mr. Thomas Chong from Credit Suisse. Please go ahead.

[Thomas Chong, Credit Suisse]

I have 2 questions. The first question is about how should we think about the impact of a macro headwinds to our business? And my second question is about any updates about the new e-commerce mall and about implementation plan? Thank you.

[Tian Xu, Vice President of Finance]

Yes. There has been a lot of discussions on the potential slowdown in China as well as growing concerns about U.S. and China trade war. While we are following macro conditions closely, we haven't yet observed impact on our business. Our GMV is still growing healthily and we're strong in terms of the user growth and all these metrics. We're feeling there is still a very strong unmet domestic demand for our users which we are doing our best to fulfill.

Ultimately, no matter how macro conditions may be the demand for value for money goods is still constantly growing, I believe, for the consumers in lower-tier cities, for instance, through our platform, they're able to find better quality goods at a similar, or even lower prices, versus whether they may be available in their local stores. So I think this is going to be a chance. And we're also able to provide such value for money goods due to our C2M model where we are aggregate users demand and try to connect this demand directly to manufacturers and merchants with the strong supply chain capability, allowing users to safe by reducing manufacturing costs and cutting down the layers of intermediary distributors. We do see our GMV growth growing faster than online good sales growth rate reported by MBS, which shows that we are continuing to gain market share at this moment.

Finally, on the trade war, I think we are fortunately relatively sheltered as our platform today is purely servicing domestic demand and our merchants manufacturing base is also mostly located in China. However, with all our staff, we are part to a bigger and larger economy, and wouldn't be fully insulated, of course. Therefore, we are also monitoring the economy and our business closely to be fully prepared for any market change in the future.

Your second question is e-commerce law. The e-commerce law marks a positive development for the Chinese e-commerce industry, I think, and it has been discussed before a long, long time even it's started even before PDD existed. We had participated very recently in several rounds of discussions with the authorities before it was published. The finalized e-commerce law is along the lines after previous drafts and has adopted many industries currently best practices.

As a platform that has been following the best of practices in the market, we welcome and fully support the condition of codification of such practices and underlying principles. And there are some rules in the law, which emphasis on the fair competition. The emphasis on fair competition is something that we think will pave the way for a more level playing field in the industry, and it may change the competitive landscape a little bit in the future as well. The areas of consumer rights and the data privacy protection are also areas that we have spent a lot of efforts on internally. We have always had a strong focus on removing infringing goods and merchants who spoil our merchants -- our consumers experience on our platform. And as I mentioned, I will be personally leading our research efforts on data privacy protection, which shows how seriously we, as a company, view this issue. We don't want to get into trouble the other companies have experienced. We expect that further consultation will be organized to provide detailed implementation guidance and procedures of the rules under the new e-commerce law as the current law is more focused on broader principles.

We will continue to participate in the consultation, and if appropriate upgrade or enhance our system and the policy in accordance with the guidance and the procedures. But it will take some time. We don't think the very detailed rules will be rolled out very soon. We believe – and it's going to be a process. We believe the government will take a balanced approach and also consider how e-commerce has helped to grow domestic demand and rejuvenate domestic manufacturing capacity to support SME growth. Thank you.

[Operator]

We have our next question coming from the line of Mr. Piyush Mubayi from Goldman Sachs. Please go ahead.

[Piyush Mubayi, Goldman Sachs]

Thank you for taking my question and congratulations on your numbers. I've got two areas of questions. The first is on your GMV growth rate, which has, no doubt, been very strong. Could you talk through the drivers of being 99% increase in annual spending per active buyers that you're seeing as well as the average team size if you've observe right now? Also, given how important 4Q is in terms of size. Could you give us a sense of how it's been tracking through the last two months, if you could comment on that? The second is on the effective take rate, which, excluding payment, we think to a certain degree to factor under your control. And it's come down about 0.4% to 2.5% in 3Q. Now we know you've described initially it's about rewarding quality merchants with traffic. Could you detail how successful this attempt has been? How many merchants you have on your platform? And how long you believe it's necessary to continue to offer this discounted traffic? And at what point of time in the forward, could we expect this to trend back up towards 2.8% or 3%? Thank you.

[Tian Xu, Vice President of Finance]

Hi, Piyush. This is Tian. We are pretty confident that our GMV will continue the strong momentum, we've seen so far. This quarter we have seen strong growth in our GMV, driven by two doublings: one is doubling in our annual active buyers, the other is doubling in the annual spending proactive buyers. Our user base distribution closely mirror the population distribution of China. And we see the great potential as the internet population in China continues to grow. This is because we are confident that our value proposition of offering value for money and the fun, entertaining shopping experience has kind of universal appeal. And it's not constrained to only a particular demographic or geography. So for those who have used our Pinduduo app, we think, you would agree that it has been a very engaging outfit for you to kill the time and discover new products, you might find some new products that you didn't even know you need. So for those who haven't used our app, we strongly encourage you to give a try.

So moving to the second part of this equation which is the annual spending per active buyer, we still see a lot of runway for our annual spending per active buyer to grow. As user mature, they came to trust the platform more and are willing to purchase a much bigger ticket items. And the fact is exponential. This is something that we have observed from our internal data. And it has increased our believing that our recent strategies are paying off with regards to improving the overall quality of our platform. And on top of that, we are also enriching our product selection. So there will be even more for our users to discover on our platform. So during the double 11/11 sales period, for example, we sold over 200,000 units of Apple's latest phones. You know the iPhone XS, XR, XS Max et cetera, which demonstrated the strong purchasing power some of our users have.

Your second question is about monetization. In order to create – as Colin mentioned, in order to create a virtuous cycle of attracting more capable and responsible merchants to our platform and also churning out the lower quality ones, we have been giving discounted traffic and discounted commission fees to some selected merchants who have been demonstrated our willingness and the capacity to serve our users better. This initiative does affect the pace of our monetization growth in the short term. Nevertheless, we believe this is the right thing to do, and this can help to drive that ecosystem in the positive way in the medium to long-term. And in general, we are not concerned by this quarterly fluctuation as we continue to experiment with different strategies, and advertising products offerings, and as we believe our efforts will eventually benefit monetization in the long run rather than the short run. And after all, we only started monetization -- monetizing our platform in the middle of the last year. So the results so far have already demonstrated that monetization can grow very healthily if merchants are seeing good returns on our platform. So overall, we still take a conservative approach towards growing our platforms monetization. I would say monetization is not our near-term goal, but a result of user satisfaction and good user experience. And we will continue to enable our ecosystem counterparties to improve their capacity and to serve our users. Thank you.

Operator next question please.

[Operator]

The next question comes from the line of Alicia Yap from Citigroup. Please go ahead.

[Alicia Yap, Citigroup]

Thanks for taking my questions. Congrats on another strong quarter. I have two questions. Number one is that since you actually have attracted the numbers of big brands to open the flagship stores on your platform recently, just wondering, have these brands been contributing to the accelerated growth of the GMV this quarter? Or these brands will still take some time to get used to our platform? And in the next few quarters, how should we think about the GMV contribution from the bigger brands versus the longer term merchants?

And second question is regarding the sales and marketing. Since there is some leverage on the expense ratio achieved this quarter, but given sales and marketing is also critical in terms of driving the top line growth. And if we look into fourth quarter given this is a seasonal promotional quarter, will the expense ratio be actually going up on percentage of sales? And then over time, is there any kind of talk of optimal percentage of sales that sales and marketing could automatically come down to? Thank you.

[Huang Zheng]

Okay, I'll answer the first question first and move your second question Tian can add a little bit. For the first question is about high-end brands. There were a lot of media talking about that. In general, my opinion is no hurry, and it's a process. But I see no reason why high-end -- higher price branded goods wouldn't transact on our platform. Just as how people are not one dimensional. Our users also have a multitude of product needs. And we think regardless of the price point, the demand for getting a good deal in a fun and entertaining way doesn't change. More and more branded merchants approaching us partially because of all this PR, negative or positive. And they've all setup shops on our platform after seeing our continued momentum. We already have merchants such as Xiaomi as a well-known cell phone brand. And also, like off-line retailers like Guomei, and also even online retailers like TomTom. They brought in an array of SKUs and brands onto our platform. During the 11/11 sales period for example, as Tian just mentioned, we sold over 200,000 units of Apple's latest phones, including iPhone XS, XR and XS Max and all these. That being said, we view every brand as we do all our merchants. And we have the same requirements that they collaborate with us and serve our users. We treat them all equal. And I believe it's just a matter of time. There will be more and more different kinds of products, different kinds of brand coming onto the platform and serving a variety of our users needs. With that's said, maybe Tian, you pick the second question first.

[Tian Xu, Vice President of Finance]

Yes, in terms of the marketing expense in the next quarters, I would say we cannot provide the guidance in terms of percentage of revenue also -- which is also depends on the revenue growth. But we look at our marketing spend as a long-term investment. And it is difficult to provide guidance because depends on the expected returns. But I can elaborate our rationale behind it. We are investing primarily to build user-trust and brand recognition. So far we have seen good ROIs on our marketing investments. And we will continue to build awareness on our brands and user engagement. And meanwhile, we are very disciplined in studying the ROI of our spending. For example, for coupons, we deploy different algorithm to do AB testing for each user group. We will track their behaviors after receiving the coupons such as any change in user intent, retention or any change in user spending et cetera. So please note that marketing spending also depends on season and opportunities. So it will not be that too linear quarter-by-quarter. For instance, in the second quarter there was a FIFA World Cup. So we shifted some advertising budget to it. And we also continued to spend on the World Cup in July, which fed into some of the sales and marketing spending you saw this quarter. Just like investors in the capital markets, when we are presented with good opportunities to make marketing investments with good returns, we will be active. So we also do not want to constrain us in this regard.

So all that said, as our general approach in terms of investing to grow our business, we look at marketing spend very thoughtfully and we'll not spend irresponsibly, but I could say in the long-term, the percentage of marketing expense -- goes down. That's pretty much what I can tell you right now. Thank you.

[Operator]

We have our next question coming from the line of Natalie Wu from CICC. Please go ahead.

[Natalie Wu, CICC]

Good evening gentlemen. Thanks for taking my question and congratulations on a very solid quarter. I have two questions here. First one, regarding Tencent collaboration, I noticed that you opened up the Weixin Wallet access last month. It would be great if management can share some color with us on the update regarding this collaboration, say how much GMV comes down from the Weixin access, the additional user growth from that channel et cetera. And I'm curious if there would be any further collaboration with WeChat next year, say more direct and more frequent, powerful access maybe.

And second question is regarding the -- your selected merchants rewarding program. Just curious, what kind of the – what type of the factors where you consider the most when choosing those high-quality merchants, which you will grant with favorable take rate and the traffic leverage? And how much does that group of the high-quality merchants account for your GMVs? Thank you.

[Huang Zheng]

I’ll answer your first question first. About Tencent -- we have been working very closely with Tencent. We appreciate and value their partnership very much. They're also a very good shareholder and have been supportive since Series B round. As disclosed, we use Tencent cloud. We also advertise on Tencent and then leverage both WeChat and QQ for our users to share interest in products together. The working teams of both companies often discuss new user trends and behavioral -- and behaviors together. In terms of transactions and the orders, actually mostly happen on our own app. And this has been a case for more than a year. This is because as users shop our platform a couple of times, they would naturally download the app to enjoy more fun and cost saving features of our app. While on social platforms are used to share products with the social context, where end-users just want to get something quickly. They may just choose to join existing team on our apps directly. The access trends is overall smoother and it provides a richer set of features for our users. And you also mentioned the icon on WeChat wallet, especially on that, as we just launched that on October 10th. So it is probably still too early to tell. And it's pretty hard, at this stage, for us to comment on the impact of that.

However, this does demonstrate the value that $0.10 fees in our platform. And overall, we're grateful to have $0.10 as a shareholder a partner and a great platform for us to learn and grow. And about future collaborations, I think, we are -- we do see a lot of areas and very concrete projects that can be done together. And it wouldn't be surprising that where we'll further collaboration a lot more. And there will be new innovations coming out of a closer relationship.

[Tian Xu, Vice President of Finance]

Yes, I would add few color on this high-quality merchants questions. We look at our high-quality merchants as a variety of factors, For instance, service quality and their specific GMV-generated et cetera. Now this strategy over rewarding these high quality merchants so far is paying off and we will continue to incentivize them to create this virtuous cycle to keep attracting better merchants to improve our user experience. So it's really hard to differentiate the GMV generated by these high-quality merchants because they improve the user experience as a whole, not only to their stores or to their specific products. Thank you

[Natalie Wu, CICC]

Thanks.

[Huang Zheng]

Generally it's pretty hard to kind of say this is high-quality merchant and that one is not high-quality merchant. I mean, it's -- a lot of times as blurred. But we do have scores and it reduces them for a different kind of merchants. So depending on the user feedback and hard to get them, we'll sort of sometimes have tailor-made commission rate or as plans for them.

[Operator]

We have our next question coming from the line of Joyce Ju from Merrill Lynch. Please go ahead.

[Joyce Ju, Merrill Lynch]

I would like to have some more colors in terms of Pinduduo's efforts in cleanup problematic like products as well as those are not authorized to merchants. Could you help us quantify the impact on overall platform as well as on GMV or other technology expenses? A quick follow-up is also want to ask if we have any specific numbers in terms of how the new e-commerce law will affect our merchant space, especially in the VAT side, what percentage of our merchants, right now are not really paying the VAT? Thanks a lot.

[Huang Zheng]

About the cleanup process and fighting against counterfeit goods, as we mentioned -- as we have mentioned on our last call, and this call, we have always been committed to fighting counterfeit goods and have ramped up our assets in the last few months. We see this as a good opportunity to make us a better platform and very grateful for the support we have received from the government and our users. In the month of September alone, we have proactively closed down over 5,500 stores on our platform, removed over 7.7 million problem products and then pre-blocked over three million links to suspected infringing products. You might have also read from the news that we have reported to the police IT violation cases of some of our merchants. And in fact, some of these merchants have already been arrested by the police. And so it's a constant battle, and we're taking it very seriously, and fought against that full heartedly actually. We will continue to invest in developing better technical solutions to enhance our ability to detect infringing items and take down items in the stores of merchants who are non-compliant. I also mentioned video imaging recognition earlier in the call. This is actually a very interesting area since they can go beyond the traditional image recognition in ascertaining the identity of the merchants applying to our platform. Such I myself like 13 years ago I was doing -- as a student, I was doing learning the image recognition and the visual recognition. And it's kind of interesting to me personally. The knowledge I learned is actually can be applied to some degree in practice and it's helping the platform and it also helping the society.

Now the vast majority of merchants on our platform are actually merchants who share our vision of providing good value for money products to our users. They just need a little bit help. Sometimes these merchants also violate some of the rules, but the majority of them are actually started doing this business out of their good intention. We are constantly pushing ourselves to do more and more -- to help these merchants. And we thought deeply about how we can better help our merchants. Many of them, in China, have the capacity to manufacture high quality products and have very strong willingness to create their own brands, but they lack resources and the distribution channel. As such we have built up Duo Duo University [ph] to help train merchants and unlock their potential. Duo Duo University [ph] has just launched in the last quarter. We have helped the merchants develop their own brands and try to make sense of their user behavior and try to advise them on how to better capitalize on the seasonal trends, and also consumer tastes in their listings. This will also raise the effectiveness of their marketing spend and

a feedback into awareness to spend on our platform. As a result, it would improve, in fact, our long-term monetization credibility.

With that said, I will also want to emphasize on the fight against the counterfeit goods. Because you asked about how -- sort of what's the effect or negative effect this fight may have on our platform? I think I need to point out that -- we fundamentally believe this is the important to take swift to action to deal with irresponsible merchants as this is the right thing to do for our platform, and the value of our company such that we will never back away from doing the right things, even if it may cause short-term frictions. A lot of new we're facing and that's the things we faced, criticism we faced in August, it is a good test of our company values. Cleaning up our own platform and incentivizing the high quality and more capable merchants, we'll ultimately improve the quality of our platform in the longer run. It is actually quite a difficult for us to try to isolate the impact of any one given action, but we take heart from the numbers that more and more users are still finding value in our platform. And in fact, the customers' action, probably we gained more support from our users. As you can see from our 3Q numbers, our active annual buyers continue to grow very fast, year-to-year its 144% growth to 386 million users already. And also it comes along with the increase of annual spending per active user. This has gone up 99% year-over-year to reach almost RMB900 per active user or per active buyer. So these numbers are actually very encouraging to us. So basically, we should always stick to our value and try to do the right thing first and then try to figure out to do the things more cleverly and to do the things right. I mean, the principle is first and then the result will come. And in our case, it looks like the result comes even faster than we expected. So all of this just encourages us to fight against those bad behaviors even more harshly and more swiftly, and it's a very good beginning of all of these. Tian, you want to add something?

[Tian Xu, Vice President of Finance]

No.

[Huang Zheng]

Is there another question?

[Joyce Ju, Merrill Lynch]

Yes.

[Tian Xu, Vice President of Finance]

Go ahead.

[Huang Zheng]

Go ahead.

[Joyce Ju, Merrill Lynch]

The follow-up questions with regarding the percentage of merchants who are now not paying the VAT, and probably subject to … yes.

[Huang Zheng]

Okay. What, Tian, do you want answer or you want to …

[Tian Xu, Vice President of Finance]

As a platform, I can say we are fully incompliant with the tax laws and regulations. And next year, we will be compliant with the e-commerce laws. So we're not in a position to track or to just the merchants tax liability.

[Huang Zheng]

Also -- remember your question you said, the merchants are not paying VAT, I think, that's not true. The merchants in different provinces are subject to different local authorities to their behavior. And I believe I mean the VAT tax is fairly common and it wouldn't change. I mean, the rules are there. I mean they won't change significantly before the law put into place or after. And also, when you – if you are asking about this very specific details and trying to drill down, then we should really wait a little bit to see the detailed kind of execution plan after e-commerce law. And with that, I think, all the e-commerce platforms are equal, they are the same, we're the same. And I don't think that sort of make any differentiation between different platforms.

[Operator]

Thank you, sir. We have our next question coming from the line of Binnie Wong from HSBC. Please go ahead.

[Binnie Wong, HSBC]

Two questions here. One is your investment priorities. So for long-term, to continue to drive better value for all merchants and to help them to grow bigger on the platform, can you tell us as areas of where management think will really have to step-up in terms of investment, say maybe in logistics or any -- because, I think, Tian mentioned that we’re more research initiative to drive better conversion. Are those things that we should expect where we'll be investing in terms of the priorities? That would be very helpful. And how are we going to drive better conversion for our merchants in our fleet? So this is my first question. And my second question, actually, I think the agriculture strategy, if you can elaborate it a little bit more both on the user side and also on the execution. On the user side because we understand there are more online leading platforms by spending their presence in the fresh food online right, and also through, of course, a modification of the traditional business model. So in terms of the competition on the user side, can you help us understand our competitive edge here? And second, is in terms of execution. I think management has emphasized that this is, of course, it's a very fragmented market in China. So what are the key challenges in terms of execution i.e. in terms of assessing, say, which farmers who have the best products, best demand for our customers, and also how do we determine the pricing et cetera? And how do we support them with the logistics? That will be my two questions. Thank you.

[Huang Zheng]

Tough two questions. But I’ll try to answer them one by one. The investment strategy, I think, we believe we have managed to be the fairly successful business thus far by staying very-focused on what we're doing at. We have a very good working relationship with the various counterparties on our ecosystem, including the logistics part. We have no ambition to do everything ourselves. In fact, we have no ambition to do anything that someone else is doing better than ours. We see ourselves as a enabler to help our merchants, manufacturers and logistics providers and other service providers who grow and improve. We will only invest strategically in areas where we think we can make a difference or providing even better user experience. With that said, you mentioned agriculture. It is a strategy, but it is also not a strategy because this is an area we see -- we can do a lot of things, and this is also an area we start with actually. We started with agriculture. Once upon a time we were selling orders kind of 100% of the things selling on our platform were fruits and agricultural products. So we should never forget about our roots, right? And if you look at the agriculture problems from the user side, you are at the kind of competitive advantage we have. So I will give you an example to demonstrate the value creation after the team purchase model we have for the peasants. For the garlic in Hunan province, the price we pay at the field is probably around RMB1 per half kilogram. And the price per half kilogram in Shanghai market or in Shanghai kind of the neighborhood, it's around RMB4 to RMB5 per half kilogram. So because -- so that's 4x to 5x right, from the fields. And that's because there is first tier, second tier and third tier middlemen in between, right? And there is a lot of moving around as a re-packaging and taking the things out and re-packages them again. So in our model, because we're able to assemble enough demand from the user side, sort of like trying to aggregate demand from this district and other districts, and all of a sudden 1,000 people, even 10,000 people, are buying the same garlic on the same day. So with that, we can actually have to peasant kind of packaging their garlic into small boxes and send that directly to Shanghai or to other cities. Although we're going to pay a little bit extra to the delivery companies, in our calculation they probably pay RMB0.6 per half kilogram because for one package, it usually comes with 2.3 or 3 kilograms each. So with that, the retail price on our platform is about RMB2 per half kilogram, so, which is almost half the price of the retail price downstairs in the stores in a supermarket. But even with this half the price, if you cut out the RMB0.6 paying to the delivery companies, the peasants at a field is still earning $0.5 more per half kilogram. So this is -- I think, the peasants earn more and users actually get the garlic at a much cheaper price, and even fresher. So it's a win-win situation. Of course, the current delivery system use to shift the garlic from Hunan province to Shanghai is not optimized for shipping agricultural products because before PDD comes into place, there is no e-commerce platform is selling agricultural products at this scale. So the current delivery system is actually optimized for shipping household goods from Jingdong province, Guangdong province to the cities or to the villages. So because of the entity team purchase model, we sort of created this kind of market and created this kind of business model. And this enables us to kind of help our deliverable companies to revise their procedures and in trying to improve the delivery of quality of those agricultural products, try to reduce the percentage of damage during the whole process. It's not an easy job to do. It's always easy to say and easy to imagine, but it's really hard to implement. But we do see a huge value creation that can be done on our part and also on delivery companies' part and also on the peasants' part. So this is the area with we're kind of very accepted upon and not only because it creates a good user experience, but will also think -- we are doing some social good. And that gives all the employees a better sense of achievement.

Does that answer your question -- answer all of your questions.

[Binnie Wong, HSBC]

Yes, I think it is. Thank you. Thank you. Thank you for the clarification. Thank you.

[Operator]

We have our next question coming from the line of Nicky Ge from China Renaissance. Please go ahead.

[Nicky Ge, China Renaissance]

Congratulations on the strong quarter. I have a question about the competition. On one side, our peers are starting to offer value for money merchandise as well, and on the other side Duo Duo is actually also penetrating to the branded merchandise segment, just wondering whether management can share your view on the competitive strategy for that? Thank you.

[Tian Xu, Vice President of Finance]

Yes, I was stopped by, say, something about these other platforms copying this team purchase model than cutting my make some compliment. We cannot speak for others who copying this team purchase model, but we are still seeing strong growth in our own models. We see growth in our active buyers and they use GMV et cetera. So in fact the recent trend of these many players adopting similar team purchase format, actually we believe they validate our business model. So I would say it's relatively easy to copy platform user interface or team purchase options, which is something we have been seeing for the last two years. But we believe what truly differentiate us from our competitors is the fundamental philosophy behind our platform. We have been focused on incentivizing our ecosystem counterparties and including those merchants' logistics providers, customer service agents, et cetera, in order to serve our user better and continuously offer them value for money products in a fun, social, dynamic shopping experience.

On top of that, what makes this possible is our distributed AI infrastructure. User preferences are complex and multidimensional. This distributed AI infrastructure we have enable us to solve complex and learning decision making problems based on the large scale social data that we have accumulated. And our system allow the source data set to change or updated itself even during the course of the computation. And this capacity serves social simulation scenarios very well. And this is our competitive advantage. And as user interact with different people, our dynamic -- this distributed AI can understand them better and avoid narrower recommendation over time. So we are the pioneer in creating farm in active shopping experience as well. We mentioned several times, our Duo Duo Orchard has seen early success already. So we will always focus on innovating disrupting ourselves to serve our users better instead of focusing on our peers or other noise in the market. So in short, we remain confident that we are well positioned to serve the needs of our users as we see those copycats.

[Huang Zheng]

I'll add a few words. I think presumably few being praised by the ones who is copying is. The more people are copying us, one way you would think they are stealing away the market share, but on the other hand you should also think they are actually enlarging their market and they’re helping educating a lot of our users. The beauty of internet platform model is that it has a very strong network effect and a first-mover advantage. So the bigger the pie is the first mover actually -- will eventually take very significantly, if not all of the whole pie. So I would actually encourage more people kind of copy and experiment in different variations. And it has been the case, as Tian pointed out, for the past two years. I guess it will continue for another two years. And hopefully, along the way some of them will invest some new formats, which we can learn from. And also, I'm fairly confident that it will well create new formats as well like other variations are paying or other kinds of Duo Duo Orchard will come out. And with those new inventions, I also encourage others to try and help us to figure out how to fine tune these models, and help educate our user base, helping educate new users and enlarge our user base. So is that okay?

[Nicky Ge, China Renaissance]

Yes. Thank you very much.

[Huang Zheng]

Okay. Thank you.

[Operator]

Thank you, sir. I would now like to hand the conference back to our speaker. Mr. Arnell, please takeover sir.

[Christian Arnell, Investor Relations]

Thank you, operator. Unfortunately that's all the time we have tonight. Thank you very much for joining us. On behalf of the entire Pinduoduo management team, we'd like to thank you for your interest and participation in today's call. If you require any further information or of any interest in visiting us in China, please do reach out to us. Thank you for joining. This concludes the call.

[Operator]

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