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Qutoutiao(QTTOY) - 2020 Q4 - Annual Report

PART I ITEM 3. KEY INFORMATION This section presents key financial data, significant risk factors, and essential investor information, detailing 2020 financial performance and core operational challenges Selected Financial Data Selected financial data reveals a decrease in net revenues but a significant narrowing of net loss in 2020, with non-GAAP adjustments provided Selected Consolidated Statement of Operations Data (2018-2020) | Indicator | 2018 (RMB '000) | 2019 (RMB '000) | 2020 (RMB '000) | 2020 (US$ '000) | | :--- | :--- | :--- | :--- | :--- | | Net revenues | 3,022,146 | 5,570,081 | 5,285,195 | 809,992 | | Gross profit | 2,518,533 | 3,929,449 | 3,610,779 | 553,376 | | Loss from operations | (1,981,613) | (2,723,232) | (1,032,169) | (158,187) | | Net loss attributable to Qutoutiao Inc. | (1,942,572) | (2,688,681) | (1,104,439) | (169,263) | | Net loss per share (Basic and diluted) | (52.69) | (39.41) | (15.69) | (2.40) | Selected Consolidated Balance Sheet Data (as of Dec 31) | Indicator | 2019 (RMB '000) | 2020 (RMB '000) | 2020 (US$ '000) | | :--- | :--- | :--- | :--- | | Total current assets | 2,692,227 | 2,472,316 | 378,899 | | Total assets | 2,940,197 | 2,915,858 | 446,875 | | Total liabilities | 3,149,696 | 3,107,695 | 476,275 | | Total Qutoutiao Inc. shareholders' equity (deficit) | (701,482) | (1,280,775) | (196,287) | Reconciliation of Non-GAAP Net Loss | Indicator | 2018 (RMB '000) | 2019 (RMB '000) | 2020 (RMB '000) | 2020 (US$ '000) | | :--- | :--- | :--- | :--- | :--- | | Net loss attributable to Qutoutiao Inc. | (1,942,572) | (2,688,681) | (1,104,439) | (169,263) | | Add: share-based compensation expenses | 951,627 | 271,979 | 463,214 | 70,992 | | Non-GAAP net loss attributable to Qutoutiao Inc. | (990,945) | (2,416,702) | (641,225) | (98,271) | Risk Factors The company faces significant risks related to its business, corporate structure, operations in China, and the trading of its ADSs Risks Relating to Our Industry and Business Operational risks include limited history, persistent net losses, reliance on user growth, strict PRC content rules, and intense competition - The company has a limited operating history, with its main application launched in 2016, making rapid historical growth not necessarily indicative of future performance43 - The company has incurred significant net losses, reporting RMB 1,945.8 million, RMB 2,689.3 million, and RMB 1,105.2 million for 2018, 2019, and 2020, respectively, and may not achieve profitability54 - A substantial majority of revenues are generated from advertising and marketing, making the business vulnerable to declines in advertising spending79 - The COVID-19 pandemic has negatively affected the advertising market in China, constraining customer advertising budgets, which could materially impact business and financial results72 Risks Relating to Our Corporate Structure The company's VIE structure in China poses risks due to enforceability, potential non-compliance, and uncertainties from the Foreign Investment Law - The company relies on contractual arrangements with its consolidated VIEs to operate its business, which may not be as effective as direct ownership and could be difficult to enforce under PRC law156157 - If the PRC government deems the VIE contractual arrangements non-compliant with foreign investment restrictions, the company could face severe penalties, including the revocation of business licenses or being forced to restructure163166 - The PRC Foreign Investment Law, effective January 1, 2020, creates substantial uncertainty as to whether controlling VIEs through contractual arrangements will be recognized as "foreign investment," potentially impacting the viability of the current corporate structure175179 Risks Relating to Doing Business in China Operating in China involves political, economic, and legal risks, including unpredictable PRC law enforcement, complex regulations, and potential delisting under the U.S. HFCA Act - The company's ADSs may be delisted under the Holding Foreign Companies Accountable Act (HFCA Act) if the Public Company Accounting Oversight Board (PCAOB) is unable to inspect its China-based auditor for three consecutive years213214 - The inability of the PCAOB to conduct inspections of auditors in China deprives investors of the benefits of such oversight and makes it more difficult to evaluate the effectiveness of the audit process219 - The business is subject to uncertainties in the interpretation and enforcement of PRC laws, which can be inconsistent and unpredictable183185 - Escalating political tensions between the United States and China could negatively impact trade, investment, and economic conditions, potentially harming the company's business and access to U.S. capital markets211 Risks Relating to the ADSs ADS investment risks include price volatility, limited shareholder influence from a dual-class structure, no anticipated dividends, and exemptions as a foreign private issuer - The trading price of the ADSs is subject to volatility due to broad market factors and investor sentiment towards Chinese companies listed in the U.S227 - The company has a dual-class share structure where Class B shares have ten votes per share, giving co-founder Mr. Eric Siliang Tan control over corporate matters with 72.9% of the aggregate voting power121627 - The company does not expect to pay cash dividends in the foreseeable future, meaning investors may only see a return if the ADS price increases230 - As a foreign private issuer and an emerging growth company, the company is exempt from certain U.S. reporting requirements, which may provide less information and protection to investors compared to U.S. domestic issuers251254 ITEM 4. INFORMATION ON THE COMPANY This section details the company's history, mobile content platforms, AI-driven business model, regulatory environment, and VIE corporate structure History and Development of the Company The company launched its flagship Qutoutiao app in 2016, Midu Novels in 2018, operates via VIEs, and completed its NASDAQ IPO in 2018 - Launched flagship mobile application Qutoutiao in June 2016 and mobile literature application Midu Novels in May 2018264 - Completed its initial public offering on the NASDAQ Global Select Market on September 14, 2018, raising approximately US$85.8 million in net proceeds266 Business Overview Qutoutiao operates AI-driven mobile content platforms targeting lower-tier cities, leveraging a loyalty program for user engagement and primarily monetizing through advertising - The company's mission is to bring fun and value to users through its mobile content platforms, Qutoutiao and Midu, which use AI-based algorithms for content personalization268 Key Operating Metrics (Q4 2020) | Metric | Value | | :--- | :--- | | Combined Average MAUs | 124.7 million | | Combined Average DAUs | 32.3 million | | Average daily time spent per DAU | 50.3 minutes | - The company strategically targets users from lower-tier cities in China, an underserved market with high monetization potential270 - A key business feature is an innovative user loyalty program where users earn points for referrals and engagement, which fosters loyalty and lowers user acquisition costs271 - Revenue is primarily generated from advertising and marketing services, powered by a proprietary programmatic advertising platform acquired in February 2018276302 Regulations The company's operations are subject to a complex PRC regulatory framework covering foreign investment, telecommunications, content, advertising, and data security, necessitating a VIE structure and various licenses - The Foreign Investment Law (effective Jan 1, 2020) creates uncertainty regarding the regulatory treatment of VIE structures316 - Foreign investment in value-added telecommunications services is restricted, with foreign equity capped at 50%, necessitating the company's use of a VIE structure to operate in China322 - The company is required to obtain and maintain various licenses, including an ICP License for information services and an Internet News License, which its VIE Shanghai Jifen obtained in July 2019321331 - Operations are subject to strict regulations on online advertising, requiring monitoring of ad content to ensure compliance and avoid penalties for false or misleading information335339 Organizational Structure Qutoutiao Inc. operates in China via a VIE structure, using contractual arrangements to control VIEs and consolidate financials, due to PRC foreign ownership restrictions - The company operates in the PRC through a VIE structure due to legal restrictions on foreign investment in internet-based businesses393 - Effective control over the VIEs is maintained through a series of contractual arrangements, including Equity Interest Pledge Agreements, Voting Rights Proxy Agreements, Exclusive Technology and Consulting Service Agreements, and Exclusive Option Agreements398400402405 - As a result of these arrangements, the company is the primary beneficiary of its consolidated VIEs and includes their financial results in its consolidated financial statements395 ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS This section analyzes the company's financial performance and condition, highlighting 2020's narrowed net loss, ongoing liquidity challenges, and a strategic shift in user metrics Operating Results In 2020, net revenues decreased, but operational efficiency improved significantly due to reduced sales and marketing expenses, leading to a narrowed net loss Year-over-Year Financial Performance (2019 vs. 2020) | Metric | 2019 (RMB) | 2020 (RMB) | Change (%) | | :--- | :--- | :--- | :--- | | Net Revenues | 5,570.1 M | 5,285.2 M | -5.1% | | Gross Profit | 3,929.4 M | 3,610.8 M | -8.1% | | Sales and Marketing Expenses | 5,489.7 M | 3,381.6 M | -38.4% | | Net Loss Attributable to Qutoutiao Inc. | (2,688.7 M) | (1,104.4 M) | +58.9% | - The decrease in advertising and marketing revenues in 2020 was primarily due to the company's strategy to balance operational efficiency and sustainable growth515 - The significant decrease in sales and marketing expenses was driven by reductions in both user acquisition expenses (down to RMB 1,720.7 million from RMB 2,932.4 million) and user engagement expenses (down to RMB 1,392.6 million from RMB 2,137.8 million) as the company optimized its loyalty programs and traffic acquisition strategy519520 - Combined average DAUs and MAUs experienced a downward trend in 2020 as the company focused more on the quality and profile of its user base rather than absolute size428 Liquidity and Capital Resources The company's liquidity is supported by past financing but faces challenges from ongoing negative operating cash flow and a significant convertible loan maturing in 2022 Cash Flow Summary (2018-2020) | Cash Flow (in thousands RMB) | 2018 | 2019 | 2020 | | :--- | :--- | :--- | :--- | | Net cash used in operating activities | (434,765) | (2,367,295) | (863,774) | | Net cash provided by/(used in) investing activities | (72,493) | (1,224,152) | 782,545 | | Net cash provided by financing activities | 2,298,044 | 1,768,001 | 307,246 | - As of December 31, 2020, the company had cash and cash equivalents of RMB 494.5 million, restricted cash of RMB 100.3 million, and short-term investments of RMB 391.0 million550 - A convertible loan of US$171.1 million from Alibaba will mature on April 4, 2022, which will have a significant impact on the company's liquidity542555 ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES This section details the company's leadership, compensation, board structure, and employees, highlighting the dual-class share structure granting significant voting control to co-founders - The board of directors is led by co-founder, chairman, and CEO Mr. Eric Siliang Tan576 - As of December 31, 2020, the company had 1,704 employees, with 51.9% in technology and product development and 27.6% in content management620 - Due to a dual-class share structure, co-founder Eric Siliang Tan beneficially owns 35.8% of total shares but controls 72.9% of the aggregate voting power627 ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS This section details major shareholders and related party transactions, primarily involving advertising and marketing services provided to entities controlled by co-founder Mr. Eric Siliang Tan Transactions with Companies Controlled by Mr. Eric Siliang Tan | Transaction Type | 2019 (RMB) | 2020 (RMB) | | :--- | :--- | :--- | | Advertising & Marketing Services Provided | 473.2 million | 250.9 million | | Amount Due from Related Parties (Year-End) | 278.2 million | 383.6 million | - The company entered into cost-per-impression (CPM) and game cooperation agreements with entities controlled by or affiliated with Mr. Eric Siliang Tan, incurring service fees639 ITEM 8. FINANCIAL INFORMATION This section covers material legal proceedings, including a contractual dispute and a shareholder class action lawsuit, and states the company's policy of not paying dividends - The company is a defendant in a putative shareholder class action lawsuit filed in August 2020, alleging violations of U.S. securities laws in connection with its IPO and secondary offering650 - A contractual dispute with Shanghai Wenji Culture Communications Co., Ltd. has led to a lawsuit seeking RMB 103.2 million and the freezing of certain company assets648 - The company has never declared or paid dividends and has no present plan to do so, intending to retain earnings for business operations and expansion652 ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The company's primary market risk is foreign exchange risk due to RMB-denominated revenues and USD-traded ADSs, with no current hedging, while interest rate and inflation risks are not significant - The company's main market risk is foreign exchange risk, as revenues are in RMB while ADSs are traded in USD. The value of an investment in ADSs will be affected by the USD/RMB exchange rate707709 - The company does not currently use any derivative financial instruments to hedge its exposure to foreign exchange risk709 - Interest rate risk and inflation risk are not considered to have a material effect on the company's results of operations712714 PART II ITEM 15. CONTROLS AND PROCEDURES Management concluded that disclosure controls and internal control over financial reporting were ineffective as of December 31, 2020, due to a material weakness in financial reporting personnel - Management concluded that as of December 31, 2020, the company's disclosure controls and procedures and internal control over financial reporting were ineffective729731 - A material weakness was identified relating to the lack of sufficient financial reporting and accounting personnel with appropriate knowledge of U.S. GAAP and SEC reporting requirements732 - Remediation efforts are underway, including hiring more qualified resources and implementing training programs, but the material weakness was not fully remediated as of December 31, 2020733 PART III ITEM 18. FINANCIAL STATEMENTS This section presents the audited consolidated financial statements for 2018-2020, prepared under U.S. GAAP, with the auditor's report emphasizing the significant convertible loan maturity in 2022 - The report includes audited consolidated financial statements for the years ended December 31, 2018, 2019, and 2020, prepared in conformity with U.S. GAAP748762 - The independent auditor's report includes an "Emphasis of Matter" paragraph highlighting the significant impact on the company's liquidity from the US$171.1 million convertible loan maturing on April 4, 2022766