PDD(US:PDD)2023-04-25 16:00PART I Introduction and Forward-Looking Information This section defines key terms used throughout the annual report and includes a forward-looking statement disclaimer regarding future business developments and financial performance - Defines key terminology for the report, including PDD Holdings, ADSs, Pinduoduo platform, Temu platform, and VIE (Variable Interest Entity)8387100 - The report contains forward-looking statements regarding business strategies, market acceptance, and competition, which are subject to known and unknown risks and uncertainties89102103 Item 3. Key Information This section provides an overview of PDD Holdings' business, its corporate structure involving a Variable Interest Entity (VIE) for China operations, and a detailed summary of principal risks - PDD Holdings is a multinational commerce group operating platforms like Pinduoduo and Temu, aiming to bring more businesses into the digital economy129 - The company operates in China through a VIE structure due to PRC restrictions on foreign investment in value-added telecommunications services, meaning ADS holders do not have direct equity ownership in the China operating entities111133119 - Revenues from the VIE and its subsidiaries constituted 56.2% of the company's total revenues in 2022, highlighting the significance of the contractual arrangements240299 - In December 2022, the PCAOB vacated its determination that it was unable to inspect auditors in mainland China and Hong Kong, reducing the immediate risk of delisting under the HFCA Act, though future uncertainty remains117387 D. Risk Factors This section details the principal risks faced by the company across various categories Risks Related to Our Business and Industry This section outlines key risks stemming from intense competition, reputational damage, and operational dependencies - The company faces intense competition from major e-commerce operators, traditional retailers, and large internet companies that may have greater resources and brand recognition5136 - The company's reputation is critical and can be harmed by negative publicity regarding counterfeit products, data security, or poor consumer services, with the Pinduoduo platform identified as a notorious market by the USTR since 201977657 - Dependence on third-party logistics and payment providers exposes the company to risks of service interruptions, failures, or increased costs that could harm operations4723 - The business is subject to complex and evolving laws regarding data privacy and cybersecurity in multiple jurisdictions, where non-compliance could lead to significant fines, regulatory investigations, and reputational damage30228235 - Although profitable in 2021 and 2022, the company incurred net losses in the past and may not maintain profitability due to increasing operating costs, investments in new initiatives like Temu, and marketing expenses6126 Risks Related to Our Corporate Structure This section addresses risks inherent in the company's Variable Interest Entity (VIE) structure and its contractual arrangements - The VIE structure, essential for China operations, relies on contractual arrangements rather than direct ownership, and if the PRC government deems these arrangements non-compliant, the company could face severe penalties, including being forced to relinquish its interests, which could render ADSs worthless27395301 - The enforceability of the VIE contracts has not been tested in a PRC court, creating uncertainty, and enforcing these rights could be costly and subject to the complexities of the PRC legal system134279 - Shareholders of the VIE, who are company employees, may have conflicts of interest that could lead them to act in ways detrimental to PDD Holdings305143 - The PDD Partnership has the right to nominate executive directors and the CEO candidate, which may limit the influence of public shareholders on corporate matters303665 Risks Related to Our Multi-jurisdictional Operations This section discusses risks associated with operating in multiple jurisdictions, particularly concerning PRC regulatory oversight and capital controls - The PRC government has significant oversight and discretion over the company's business, and changes in laws, regulations, or policies could materially impact operations and the value of ADSs316123967 - While the PCAOB can currently inspect the company's auditor, if this access is revoked in the future, the company's ADSs could be prohibited from trading in the U.S. under the HFCA Act124386365 - PRC government controls on currency conversion and capital flows may restrict the ability of PRC subsidiaries to transfer funds or pay dividends to the offshore holding company, limiting its ability to fund operations or distribute profits145323350 - There is a risk that the company could be classified as a PRC resident enterprise for tax purposes, which would subject it to a 25% tax on its worldwide income and could result in PRC withholding taxes on dividends paid to non-PRC shareholders331378358 - Future offshore offerings may require approval from the CSRC or other PRC authorities, and failure to obtain such approvals could result in penalties and hinder access to capital markets672185362 Risks Related to Our ADSs This section highlights risks specific to the company's American Depositary Shares, including price volatility and shareholder rights - The trading price of the company's ADSs has been and may continue to be volatile due to market factors, industry performance, and company-specific news674367 - The company does not expect to pay cash dividends in the foreseeable future, meaning investors must rely on ADS price appreciation for returns395372396 - As a Cayman Islands company, shareholder rights and legal protections may differ from those in the U.S., potentially making it more difficult for shareholders to protect their interests398418399 - The deposit agreements for the ADSs include a waiver of the right to a jury trial for claims arising under the agreements, which could limit legal recourse for ADS holders419420 Item 4. Information on the Company This section details the company's history, business operations, organizational structure, and the complex regulatory landscape it navigates - The company commenced commercial operations in 2015 and was renamed from Pinduoduo Inc. to PDD Holdings Inc. in February 2023462466 - The Pinduoduo platform pioneered a team purchase model to encourage social sharing and create a virtuous cycle between buyers and merchants, and the company also launched the global online platform Temu in September 2022490491528 - The company operates its PRC business through a VIE structure, relying on a series of contractual agreements (e.g., Exclusive Option, Equity Pledge) to control its PRC operating entities and consolidate their financial results464434 - The business is subject to extensive PRC regulations, including those governing foreign investment in value-added telecommunications, e-commerce operations, data security, and cybersecurity reviews for overseas listings510533553 A. History and Development of the Company This section traces the company's incorporation, operational milestones, and significant financing activities - The company was incorporated in the Cayman Islands in April 2015 and commenced operations through its VIE structure, later renamed from Pinduoduo Inc. to PDD Holdings Inc. in February 2023462463466 - The company has conducted several major financing rounds, including its IPO in July 2018, follow-on offerings, and convertible senior notes offerings in 2019 and 2020484 B. Business Overview This section describes the company's core platforms, business models, and competitive landscape - The Pinduoduo platform offers a comprehensive selection of merchandise and uses a team purchase model to drive user engagement through social networks470490 - The company launched Duo Duo Grocery, a next-day grocery pick-up service, in 2020 and the global e-commerce platform Temu in September 2022496528 - A key corporate social responsibility focus is on agriculture, aiming to promote digital inclusion for farmers and improve the farm-to-table supply chain through initiatives like the 10 Billion Agriculture Initiative501502 - The company faces intense competition from major e-commerce operators and traditional retailers, competing on factors like price, product selection, user experience, and brand recognition523524 C. Organizational Structure This section details the company's corporate structure, emphasizing the Variable Interest Entity (VIE) arrangements for PRC operations - PDD Holdings is a Cayman Islands holding company that controls its PRC operating entities through a VIE structure to comply with Chinese laws restricting foreign investment in value-added telecommunications services111133 - Control over the VIE (Hangzhou Aimi) is established through a series of contractual arrangements, including a Shareholders' Voting Rights Proxy Agreement, Equity Pledge Agreement, and Exclusive Option Agreement434403404 - PRC legal counsel has opined that the VIE structure and contractual arrangements are valid and enforceable, but substantial uncertainties remain regarding their interpretation and application by PRC authorities409410 Item 5. Operating and Financial Review and Prospects This section provides management's discussion and analysis of the company's financial performance, covering revenues, costs, liquidity, and critical accounting policies Consolidated Revenue Breakdown (2020-2022) | Revenue Source | 2020 (RMB in thousands) | 2021 (RMB in thousands) | 2022 (RMB in thousands) | | :--- | :--- | :--- | :--- | | Online marketing services and others | 47,953,779 | 72,563,402 | 102,721,924 | | Transaction services | 5,787,415 | 14,140,449 | 27,626,494 | | Merchandise sales | 5,750,671 | 7,246,088 | 209,171 | | Total revenues | 59,491,865 | 93,949,939 | 130,557,589 | Key Profitability Metrics (2020-2022) | Metric | 2020 (RMB in thousands) | 2021 (RMB in thousands) | 2022 (RMB in thousands) | | :--- | :--- | :--- | :--- | | Gross Profit | 40,213,224 | 62,231,846 | 99,095,291 | | Operating (Loss)/Profit | (9,380,325) | 6,896,762 | 30,401,921 | | Net (Loss)/Income | (7,179,742) | 7,768,670 | 31,538,062 | - Total operating expenses increased by 24.1% in 2022 to RMB 68.7 billion, driven by higher sales & marketing and general & administrative costs717 - As of December 31, 2022, the company held RMB 34.3 billion in cash and cash equivalents and RMB 115.1 billion in short-term investments, indicating a strong liquidity position779653 - Net cash from operating activities was RMB 48.5 billion in 2022, a significant increase from RMB 28.8 billion in 2021759761 Item 6. Directors, Senior Management and Employees This section provides information on the company's leadership, governance structure, workforce, and compensation policies - The company has an executive partnership, the PDD Partnership, which has the right to nominate executive directors and the CEO candidate, influencing corporate governance820825849 - As of December 31, 2022, the company had 12,992 employees, with the largest group (6,444) in product development11971198 - The company utilizes two main share incentive plans, the 2015 Plan and the 2018 Plan, to grant equity awards to employees, directors, and consultants866893 Share Ownership of Major Shareholders (as of Feb 28, 2023) | Principal Shareholder | Percentage Owned | | :--- | :--- | | Entities affiliated with Zheng Huang | 26.5% | | Entities affiliated with Tencent | 14.7% | | Entities affiliated with PDD Partnership | 7.0% | Item 7. Major Shareholders and Related Party Transactions This section outlines the company's major shareholders and details its transactions with related parties, including a strategic cooperation agreement with Tencent - The company has a strategic cooperation framework agreement with Tencent, a principal shareholder, covering payment solutions, cloud services, and user engagement1112 - In 2022, the company purchased services totaling RMB 7.1 billion (US$1.0 billion) from Tencent, including payment processing, advertising, and cloud services1113 - To mitigate payment service provider risk, the company provided interest-free loans of RMB 697.6 million to an entity controlled by executive officers to acquire a controlling interest in Shanghai Fufeitong, a licensed payment service company1116 Item 8. Financial Information This section contains the company's consolidated financial statements and provides information on legal proceedings and dividend policy - The company has faced several putative shareholder class action lawsuits in the U.S. related to its IPO disclosures; these cases were dismissed12481210 - The company does not currently plan to pay any cash dividends, intending to retain earnings to operate and expand the business12491212 Item 10. Additional Information This section provides supplementary details about the company's corporate governance and tax status, including share classes and PFIC rules - The company's ordinary shares are divided into Class A (1 vote per share) and Class B (10 votes per share), with Class B shares convertible to Class A but not vice-versa12031260 - The company is an exempted company under Cayman Islands law, which has different corporate governance standards than the U.S., for example, it is not required to have an annual general meeting13021265 - The company does not believe it was a Passive Foreign Investment Company (PFIC) for the 2022 taxable year but notes that the determination is factual and made annually, so no assurance can be given for future years4591316 Item 11. Quantitative and Qualitative Disclosures about Market Risk This section discusses the company's exposure to various market risks, primarily foreign exchange and interest rate fluctuations - The primary market risk is foreign exchange risk, as the company's business is valued in RMB while its ADSs are traded in U.S. dollars, and appreciation of the RMB against the USD would adversely affect the RMB amount received from converting USD13661367 - The company is exposed to interest rate risk on its cash, restricted cash, and short-term investments, but has not used derivatives to manage this risk1392 PART II Item 15. Controls and Procedures This section reports on the effectiveness of the company's internal controls, including disclosure controls and internal control over financial reporting - Management concluded that the company's disclosure controls and procedures were effective as of December 31, 20221415 - Based on the COSO framework, management concluded that the company's internal control over financial reporting was effective as of December 31, 2022, an assessment audited by Ernst & Young Hua Ming LLP, which provided an unqualified opinion14161418 Item 16. Other Information This section covers various governance and compliance topics, including the audit committee's financial expert, code of ethics, and principal accountant fees - The board has determined that Mr. Anthony Kam Ping Leung is an audit committee financial expert1421 Principal Accountant Fees (in thousands US$) | Fee Category | 2021 | 2022 | | :--- | :--- | :--- | | Audit fees | $3,099 | $3,042 | | All other fees | $71 | $74 | - In December 2022, the PCAOB removed mainland China and Hong Kong from its list of jurisdictions where it cannot inspect or investigate auditors, consequently, the company does not expect to be identified as a Commission-Identified Issuer under the HFCA Act after filing this report987 PART III Item 18. Financial Statements This section contains the complete audited consolidated financial statements for PDD Holdings Inc. for fiscal years 2020-2022, prepared in conformity with U.S. GAAP - The financial statements were audited by Ernst & Young Hua Ming LLP, which issued an unqualified opinion on the financial statements and the company's internal control over financial reporting as of December 31, 202210121013 - A critical audit matter identified was the classification of incentives provided to consumers, which involves significant judgment in determining whether they represent payments to merchant-customers (a reduction of revenue) or marketing expenses1019 Notes to the Consolidated Financial Statements This section provides detailed explanations of the company's significant accounting policies and financial statement disclosures - The company consolidates its VIE and its subsidiaries because, through contractual agreements, it has the power to direct their activities and the right to receive their economic benefits, despite not having equity ownership1055 - Revenue from online marketing services is recognized primarily on a cost-per-click basis when consumers click on product listings, while transaction service fees are recognized when a sales transaction is completed11041106 - The company adopted ASU 2020-06 in 2022, simplifying the accounting for its convertible bonds by no longer separating them into liability and equity components, which resulted in an adjustment to retained earnings12391241 - As of December 31, 2022, the company had RMB 8.6 billion in unrecognized share-based compensation expense related to unvested options, expected to be recognized over a weighted-average period of 2.44 years1291 Item 19. Exhibits This section lists all the exhibits filed as part of the annual report, including key corporate documents and certifications - Lists key legal and corporate documents filed with the report, including the company's articles of association, indentures for its convertible notes, and share incentive plans994998 - Includes English translations of the contractual agreements that form the basis of the VIE structure, such as the Equity Pledge Agreement and Exclusive Option Agreement998