Earnings Call: Q1 2019

May 10, 2019

Welcome to our Q1 2019 Earnings Conference Call. Joining me today on the call are jd.comgroupCEO, Richard Liu Mr. Xu Lei, CEO of JD Retail Mr. Wang Zhenhui, CEO of JD Logistics Sidney Huang, our CFO and John Liu, our CFO. For today's agenda, Mr. Huang will discuss business highlights for the Q1 of 2019. Other management will join the call later. Before we continue, I refer you to our statements in the earnings press release, which applies to this call as we will make forward looking statements. Also, this call includes discussions of certain non GAAP financial measures. Please refer to our earnings release, which contains a reconciliation of the non GAAP financial measures to the most directly comparable GAAP measures. Finally, please note that unless otherwise stated, all the figures mentioned during this conference call are in RMB. Now, I would like to turn the call over to our CFO, Sidney. Thank you, Ruiyu, and welcome, everyone. Thank you for joining us today. We are pleased to report a strong set of financial results for the Q1 of 2019. We delivered solid revenue growth in a seasonally low quarter and set new records across all major earnings metrics. During the Q1 of 2019, our net revenues grew 20.9%, more than double Chinese national retail sales growth. Net service revenues grew by 44% year over year, driven by solid momentum from our marketplace and advertising service revenues, while logistics and other service revenues grew over 91%. Gross margin in the Q1 was 15%, up from 14.1% in the same period last year, consistent with our prior commitment to the continued margin improvement of JD Retail, formerly known as JD Mall, and JD Logistics' 3rd party business. JD Retail gross margin increased 36 basis points, mainly driven by economies of scale from the 1P business as well as technology driven advertising revenue growth. In fact, this marks the 20th consecutive quarter of JD Retail gross margin expansion on a year over year basis. It demonstrates the long term trajectory of retail scale economies, a concept that we have articulated persistently since our IPO 5 years ago. At times, this powerful underlying trend was overshadowed by the short term accounting losses from the various new innovation efforts to extend our business model in order to drive our next growth curve. But every time when some of these short term losses were reduced or eliminated through natural progression to success or even failure, the underlying economic trend of our core business will suddenly become too obvious. Even though we did disclose such underlying trend of JD Retail market every quarter. Well, this is one of these quarters, as JD Logistics' 3rd party business achieved a significant gross margin improvement through better scale and capacity utilization that we promised a year ago, which explained the remainder of the group level gross margin expansion and restored our normal margin trend. By the same token, our fulfillment expense ratio in the Q1 also improved 0.5% to 6.7%, down from 7.2% in the same quarter last year, driven by better utilization of our logistics infrastructure and improved unit economics as a result of the Baozhi logistics service business. These improvements happened before the recently announced wage and benefit changes in our delivery unit in April. As we communicated internally and publicly, the new changes are designed to better incentivize our delivery staff in light of our expanding business lines and industry best practices. In fact, the majority of our delivery staff affected by the new incentive scheme saw their monthly income increase in April, while their productivity also improved. As such, we do not expect to realize any meaningful cost savings from these new changes. Any further fulfillment efficiency improvement will continue to come from better productivity of our staff and a better utilization of our infrastructure through scale and technological innovation. Consistent with our ongoing focus on technology innovation, during the Q1, our R and D spending was the only major expense line that increased faster than revenue growth, up 54% from the same quarter last year. Our R and D expense ratio was 3.1%, up from 2.4% in the same period last year. As we mentioned in the last quarter, however, following a period of significant investments to strengthen our R and D team, we expect our R and D expenses to stabilize in the remaining quarters of this year. Our marketing expense ratio was 3.3% in the Q1, down from 3.5% in the same quarter last year as we fine tune our marketing strategies in light of the competitive dynamics. Our G and A expense ratio remained stable at 1.1% in the Q1. Now you can see why our non GAAP operating income reached a record high of nearly RMB2 1,000,000,000 during the Q1 this year. It has nothing to do with our annual reorganization that was apparently over interpreted by certain media outlets. There is no massive layoff. In fact, our total headcount increased during a seasonally slow quarter from 178,000 at last year end to 179,000 as of March 31. In a nutshell, the record earnings is a natural result of ongoing JD Retail Margin Expansion and JD Logistics Margin Recovery, driven by technology innovation, economies of scale and better capacity utilization. Our non GAAP operating margin was 1.6%, up from 0.8% in the same quarter last year. If you ask me how sustainable this margin trend will be, I will reiterate that the improving retail JD Retail margin trend is sustainable on an annual basis, as we have demonstrated over the past 3 years, and will continue for many years ahead of us. It is driven by JD Retail's significantly lower operating expense ratio as compared to the offline retail format, which in turn will enable us to provide everyday low prices and superior services to our consumers and drive sustained growth above the market. This is the simplest yet most powerful retail economics that have supported essentially all of the most valuable retailers around the world. Our non GAAP net income attributable to ordinary shareholders in the first quarter 2019 also reached a record RMB3.3 billion, with a record non GAAP net margin of over 2.7%, up from 1% in the same quarter a year ago. Our GAAP net income also set a standard at RMB7.3 billion in the Q1, mainly attributable to the fair value change of investments during the quarter. Our free cash flow during the Q1 turned positive to RMB1.3 billion, driven by positive operating cash flow and disposal proceeds from the available for sale projects, partially offset by reduced maintenance capital expenditures. On the Q2 financial outlook, we expect net revenue growth to be between 19% 23% on a year over year basis based on recent economic indicators and our April growth momentum. Lastly, I'm pleased to share 2 exciting developments. We are delighted to extend our strategic partnership agreement with Tencent, covering a broad spectrum of strategic and business collaboration initiatives. We continue to expect a winning relationship with mutual benefits to both corporations in the future. I'm also pleased to highlight the signing of the Series A financing for our JD Health Business Group, led by a group of well respected financial and strategic investors. The deal valued our healthcare business at a post money valuation of approximately US7 $1,000,000,000 JD Health operates the largest online retail pharmacy in China with a fast growing online healthcare services platform. This concludes my prepared remarks. Now I will turn the call to Richard for a few words. Hi, everyone. This is Richard Liu. I just want to share with you, as you knew, this quarter, our net profit is a little bit high. But I want to say, we would never ever stop investing for our long term future. And we never stop for 4 fields. First, we would never ever stop investing for our customer experience. 2nd, we will never ever stop for investing for our new business. As you know, we have our JD Digital business, JD Logistics, Media Health and we will invest more for new business model. And 3rd, we will keep investing for our technology, because we are quite sure only that technology can improve our efficiency, reduce our cost and our customer experience. And last of all, this is mostly investments. That is talent investment. Actually, I'm sure the talent pool is only based on our average advantage. So we will continue improve our employees' net income. Actually, in the past 6 years, every year, our average employee net income improved. And we will keep invest and make sure every position in my company is strongly attractive, make sure we have the best talent. Thank you. Operator, let's move to the Q and A section. Ladies and gentlemen, we will now begin the question and answer session. In order to be fair to all callers who wish to ask questions, Your first question comes from the line of Mr. Ronald Keung from Goldman Sachs. Please ask your question. Thank you and congratulations on the strong results. Thank you, Richard, Shudong, Wangzong, Sydney, Baozong and Ruiyu. And very solid guidance as well. So my question is on logistics and we see a significant reduction in logistics drag and over 90% growth in the line of logistics and other services revenue. Could you share with us some of the key initiatives and maybe KPIs for the JD Logistics? And given that the gross margins did improve, as Sidney, you mentioned, significantly in the Q1, how should we think about that gross margin trajectory for the 3TL business and potentially the fulfillment cost metric as well over this year and in the outlook? Thank you. Our key core KPIs are still centered around the experience and efficiency. As pointed out by Chairman Richard Liu just announced, we will pay a lot of attention to how our customers comment on the experience. And also, we will pay attention to how fast how well we send our products to our customers. In the past quarter, we've been making efforts in these 2 aspects. One driver is technology. We have lots of very good strong supply chain and logistics technology. Through better customer experience, we can secure more orders from our customers. Although, first quarter actually is kind of an off season off peak season for us, yet we've made a quite good performance. And also, our profit margin from 3P orders of business has been very improvement during the past 2 quarters. We say this trend will continue in the future. Of course, we will not Your next question comes from the line of Jim Yoon from New Street Research. Please ask your question. Hi, good evening. Thanks for taking my question. Sidney, very strong beat to the net margin line compared to what you kind of guided for full year. How should we look at that? How should we look at the operating margin leverage as well as gross margin leverage as we kind of head into weaker seasonality for margins in 2Q and 4Q? And how should we see the cadence for margin expectations for the rest of the year? And is there and do you still maintain the same margin guidance? Or do you expect that to kind of trend upwards going forward? Any kind of color on that, that would be great. Thanks. Sure. So we're obviously very encouraged by very strong results in Q1, but it is still only Q1. As Richard mentioned, we'll continue to invest in our customer experience. We'll invest in new businesses. And also, as you can see in China, the competitive dynamic changes very quickly and has always been very, very fierce competitive environment. So, it is because only after the Q1, we have not adjusted the margin guidance. We will revisit the margin guidance next quarter for sure. Now, with very strong Q1, we are also prepared to reinvest part of that gain back to our consumers through our Q2 promotion season, very similar to what we did in 2017. But again, I think we it's a great quarter that we again demonstrated the underlying earnings power of our business. And we will not clearly, we'll continue to deliver a steadily improving margin on an annual basis, making sure that we will generate solid shareholder returns, but at the same time, only when we continue to reinvest, we can expect sustained growth for our business in a very long term basis. Your next question comes from the line of Alex Yao from JPMorgan. Please ask your question. Hi, good evening, everyone. Thank you for taking my question and I just want to dig into the logistic improving gross margin trend a little bit. So you guys mentioned the gross margin for the 3rd party logistics continued to improve in the past 2 quarters. Is it because you increased the pricing for your product or you optimized the cost structure such that the fixed portion of the allocation can be more easily scaled down by improving order volume. Can you just help us understand what exactly is driving the logistic margin improvement and how sustainable these drivers are? Thank you. Yes. So let me take that. If you recall, in Q1 last year and probably Q2 last year, we mentioned when we first started expanding the external business for logistics, we didn't it's very difficult to predict how fast we can grow, especially the effort started in Double 11 promotion season in 2017. So we essentially build out very large capacities ahead of time to ensure the new customers can enjoy the best experience. And also in conjunction with that new business expansion, we were also providing business customers with trial period preferential rates. So it was basically a capacity issue plus a discounted rates, both affected the gross margin of our external business and also because the capacity is shared by both internal and external businesses. So, our internal JD Retail fulfillment expense was also affected because we spread out the cost between internal and external. So Q1 last year was negatively affected by those two factors and essentially those two factors were removed by the last two quarters. We mentioned the initial discounted period gradually phased out in the second half of last year and then our capacity utilization has continuously improved throughout the year last year. So by now, we are in a very good shape in terms of capacity utilization and we are back to a more normalized rate that are paid by our happy customers. I don't know if that answers your question. Your next question comes from the line of Eddie Leung from Bank of America Merrill Lynch. Please ask your question. Good evening. Thank you for taking my questions. I have two questions related to your revenue mix. We have seen electronics and home appliance growth slowing down. So just wonder, will that affect our 1P gross margin improvement in future, given perhaps a slower improvement in economic scale to your suppliers? And then separately, also about the revenue mix going to general merchandise. As general merchandise is growing faster, could you talk about the trend of your basket size per user? And how would that affect the efficiency of your fulfillment business going forward, especially given the potential lower order size could demand pretty similar utilization of your logistic resources as well? Thank you. Okay. So, I'll take the first one. Our electronics and home appliance business has actually seen healthy growth in light of the overall macro slowdown and we're definitely growing well above the industry. So, the growth rate, even though it's below the historical level, but we are continuing to expanding at double digit rates and taking market share at a very fast pace. So as we take market share, you continue to be able to work with your suppliers and brands to come up with more innovative products and offerings to our consumers. We mentioned in the past for certain categories where we are already number 1, we may come up with more customized models where we can drive further customer value, meaning lower price without disrupting the offline pricing systems. And then for some other categories where we are not number 1 yet, the simple growth in scale by itself will automatically generate additional gross margin by better procurement prices. And Xu Lei can answer the second question. This is Mr. From CEO of JD Retail. Let me take the second question about the particular or best size of general merchandise? The relationship you've mentioned about the size of the ticket price and fulfillment expenses. I think it's mainly about our direct sale business. Actually, the particular price of our direct to sales business in general merchandise is our selling right. This is mainly due to the fact that we've made some efforts in the second tier categories in marketing. As a result, we'll see improved the ticket collection conversion rate. And also, we tried once last year, we reduced the freight fee from a higher price to 99. As a result, actually found out this measure didn't affect the thickness of our users, our customers in general merchandise and it helps us to control our fulfillment expenditure. And we're also starting in the end of March and also beginning of April. We've been trying or experimenting with the new measure where first buyers can enjoy free freight service. And we found actually it's very effective in acquiring new users. This test will go on for a while and then we will roll this out. Of course, the 3 year freight expenditure will be counted as new user acquisition cost. Your next question comes from the line of Alicia Yap from Citigroup. Please ask your question. Hi, thank you. Good evening, management. Thanks for taking my questions. Also congrats on the strong sets of results. I have a question, Cindy, on the Q2 guidance. Can you elaborate the drivers that contribute to the reaccelerated growth for the Q2 net revenue guidance that you provide? Has that guidance baked into any potential uncertainty on this ongoing trade war industry? Or are you not expecting any issue from this overhang? And should we also think about these reacceleration potentially is driven by, given Richard mentioned, to reinvest the strong 1Q margin. Is that suggesting you are going to reinvest into very aggressive sales and marketing promotions to drive your June 18 sales that baked into your guidance as well? Thank you. Sure. Yes. So it's really driven by a combination of factors. One is that we actually have a pretty strong April sales results. So that was very encouraging. We believe it's driven by our customer experience and also better technologies, in particular, our user interface through the personalized technologies that we believe are generating better conversion. And also on a year over year basis, if you recall, June 18 last year was a long holiday weekend and there was also World Cup around the same time. So there's also some difference in terms of sales season, seasonality or sales season timeframe. And then also, also, the third factor will be that given we do have a strong Q1, we do have better resources to reinvest. Now having said that, any investments will be also very measured. We will make sure that any investment will generate good ROI and also improve our customer experience. So the reinvestment is not just simple it's just a simple promotion. There will be various innovative marketing campaigns that are being planned. But yes, clearly the price benefit will also be part of it. That's how we return to our consumers. Your next question comes from the line of Jerry Liu from UBS. Please ask your question. Hi, thank you. Richard, my question in the Q1, we should expect some of that to be reinvested. But I want to understand maybe your longer term view. When you look at the last few years, JD net margins have had some years of increase and some years of decrease. Given the bigger scale of the business now, do you think we could enter a period where margins steadily increase year by year? Thank you. So yes, literally just So let me try to answer this question. We did have internal discussion on this. As we communicated in the past, we have been committing to steadily improving margins year over year. Now, last year was the exception where we invested heavily in technologies and also a few new initiatives such as JD Logistics. And we tried to make clear that 1, JD Retail will continue to improve in margin as we did and 2 is that we accelerated our monetization effort on the logistics properties business, so that we can in some way make up the profit shortfall last year, which also has been materialized, as we mentioned in the Q1 earnings release through our first core fund established with GIC. So, we are taking the revenue trend very seriously and we have also guided on retention this year. Clearly, the intention from Richard is to ensure that margin will steadily improve, while we will reinvest at the same time. So it is really a balance and we hope we will master better this balance going forward. Your next question comes from the line of Natalie Wu from CICC. Please ask your question. Hi, good evening. Thanks for taking my question and congratulations on very robust results. My question is regarding the new app interface. I noticed that you've launched AB testing for a new app interface that emphasize on the recommendation feed and the personalization. I was just wondering, can we get some color on the effect of this new app interface on your CR conversion rate based on the recent AB testing? And how should we think about the growth for your advertising business this year? Thank you. We've already rolled out the new version of our app 8.0. And by the end of this month, Trey, we will roll data out to all users. Of course, the users have to download a new version of the app. So it may take some people longer time. So as the time goes on, our coverage will increase. As you know, our platform has been performing very well in terms of providing the right products to the right people at a faster speed and also very precise, so to speak, save time for our customers. So we've been doing very well in this aspect. But at the same time, we also see the trend, especially among younger users. They not necessarily want to save time by shopping. They want to kill time by shopping around. That's why we started this project last year, August or September last year. So this new version will be more actually this new version is more catered to the taste preferences for young people. It's more fashion. And also there will be more interactive opportunities. For us, the metrics we use to evaluate our new version is, again, customer experience and also the conversion rate, as you mentioned, and also the efficiency in traffic distribution on home page and also on product detail page. So far, it has been doing very well in terms of TVUV increase. And also return rate. And as you know, this new model for newsfeed has already been used by some of our industrial peers. And the result is that their research their search rate actually has been hurt. However, this hasn't happened in our story. UOB from search as a percentage of total UOB has remained constant. That means we've maintained our competitive edge, at the same time we've improved the queue time part of the story, so to speak. Besides the improvement in PBM and UV on the product detail page, we found that this new version has also helped us in attracting more TV Snubbies into the stores and also the content page. At the same time, the personalized user interface and user feed also helped us to increase our advertising inventory. And of course, the results will be kicked in the following quarters. And last, I want to emphasize one point. This new user interface, it's a long term effort. It's a long term endeavor. It means that we have to make continuous efforts to optimize our algorithm. So that's a point we want to make. Thank you. Your next question comes from the line of John Choi from Daiwa. Please ask your question. Good evening and good morning. Thank you for taking my question. I have a question a couple of questions here. First on collaboration with Tencent. Has there been any further discussion about in the e commerce space with Tencent and how you guys will further collaborate and cooperate with Tencent? And secondly, if you look at your active customer accounts, it has been pretty much flattish for the past few quarters. So going forward, what kind of user acquisition strategy the management has to further accelerate the user growth? Thank you. This is John Liao and I will answer the first question. Now, of course, the past 5 years JD has a very strong relationship with Tencent and the relationship has been extremely successful. Now, the extension of our relationship with Tencent for the next 3 years and obviously we are continuing and we are deepening our relationships in 3 major areas. 1 is level 1 and level 2, gateway access Number 2, in terms of advertisement. Number 3, in terms of membership in Tencent Video and QQ Music. Now in terms of user acquisition, I will turn over to Mr. Xu Lei to provide more explanations. During the past 5 years of cooperation with Tencent, we have built up a strong client base and also brand awareness and also business size in the Weixin WeChat market. In the past 5 years, WeChat has been evolving a lot in terms of the number of users and also what they do using Google Playtech, especially in the area of retail or e commerce, they've been becoming more and more active. For example, we've been at the 1st tier base rate or court for 5 years, but still we found actually more than 50% of the visits are new visits. That means there's still ample room for growth. So we determined to defer our operation with Tencent and we'll do more innovation and also differentiated measures in terms of leveraging this partnership. That answers your second question. Let me say something about users in other aspects. As I said last time, we've been making a lot of efforts in terms of acquiring new customers. In terms of organization, we've put together all the resources or unified all the resources in this the resources or unified all the resources in this aspect, which again set up a specialized team in charge of new user acquisition. As a result, our new users have been increasing tremendously without incurring a lot of cost. Also, we've been doing 2 pilot projects in terms of creating new engagement scenarios to acquire new customers in the second quarter will step up efforts in this Another thing was done in the past quarter is that we've made efforts in awakening or reactivating customers that haven't bought anything from us in the past 12 months. As we all know, the current active client base is composed of 2 parts. 1 is new users, new user acquisition, In the Q1, we've put more resources in this aspect and also we've utilized new technologies and some innovative crop operation. As a result, the so called awakened or reactivated user base has been very promising. Your next question comes from the line of Grace Chen from Morgan Stanley. Please ask your question. Hi, thank you. Congratulations for the strong results of the Q1. My question is about the operating margin. So we see the JD Retail, JD Mall operating margin has been increasing on year over year basis. Last year was 1.6 percent and we also see encouraging improvements in the Q1. So it would be great if the management can share with us the long term margin target for JD Retail. And given that scale is the key driver of the margin expansion, so I'm wondering what kind of GMV targets can we achieve this OP margin target? Thank you. So we have discussed in the past, in China, the retail market is almost as large as the U. S. Market, while the top retailers still contribute a small fraction of the overall retail pie, while the top, for example, top 20 retailers in the U. S. Already contributed 50% of the overall retail volume. So in China, even though JD is the largest retailer, we are still quite small comparing to very large market size. So the growth outlook and in terms of when we can get to the right scale, if you just think about take Walmart of U. S. As an example, by 2018 revenue size, even just with U. S. Revenue size of Walmart, we are still only about 1 sixth of its size. So the growth potential is tremendous and that is why we are willing to reinvest part of the profitability back to the business to drive growth because as you continue to grow, your scale economies will naturally kick in. In. And the faster we grow, the earlier we can get there. So, in terms of long term margin trajectory, we had mentioned in the past, even at IPO, our first party business longer term, because we have a much better operating structure, Our expense ratio when comparing to the top 5 offline retailers, for example, our JD Retail expense ratio was 5 percentage point lower. And that is tremendous advantage for us to reinvest part of the gross margin and we can afford to reinvest the gross margin to drive growth. But longer term, when we get to the steady state, this better operating margin or expense ratio will enable us to actually earn a higher margin than offline retailers. We have maintained that we should be able to earn 2 to 3 percentage points higher margin than offline retailer just for our 1P business. And then the 3P business has a much higher accounting margin. So if you layer that on top of the 1P business, it will give you somewhere in high single digit at least for our long term JD Retail margin profile. Your next question comes from the line of Tian Hou from T. H. Capital. Please ask your question. Congratulations on the good results. My question is much more broad related to the China underlying e commerce development. Recently, we saw so many e commerce company IPO. So if we categorize those e commerce, we can say you guys and your peers are much more centralized leaders in the e commerce front, but the other guys like Yunji, Yu Zhan, such as Wuhan, are much more decentralized e commerce. And for those kind of decentralized e commerce vendors, we can actually see millions of them, big and small. And do you see any future impact from those mushroom type of growth of those decentralized e commerce vendors? Are they going to eat into your market shares in your major categories? And how are you going to prevent them from getting into your space? That's my question. Thank you. This is John, and I'll answer this question briefly. Now remember, I believe last year, we talked about a strategy called Retail as a Service, which means JD will be a I mean, it's a retailer, but more importantly, retail infrastructure service providers. Now, you're absolutely right. I think the retail space will become more fragmented and more decentralized than concentration, which means we'll continue to observe an increased number of players moving from social space, content, so on and so forth. But the trend will continue, but at the same time, it is inconceivable low single retailers will be able to build those sophisticated network based retail structure. So in this case, it was the reason why JD is moving away from a vertical integrated model to become an open model. So in this case, we opened up our retail infrastructure to connect, to enable and empower more retail innovation. So in other words, on one hand, JD for sure will continue to participate in those retail innovation, but at the same time, we will become a retail service provider to build the retail ecosystem. So those retail innovations will utilize our retail infrastructure like logistics and the other service as well. Yes. So, John has brought up this very interesting value proposition that we started mentioned last year, retail as a service, which is really part of our second growth curve, which we have seen very good progress so far. But I just also want to just come back to the basics. What you mentioned, on the various decentralized retail formats, you can also draw comparison to the various innovative boutique shops in the offline world. I think in every at different times, you always have different new innovative retail format, but in the end, the retail economies of scale driven by large procurement and also operating efficiency will remain intact. I think even with all these new online or e commerce formats, JD remains the only and clearly the largest and only 1P retailer, which mainly operating on the top end of the market. So I think on that particular unique advantage, most investors and analysts have somewhat overlooked and this is a long term gain, but when you view such a scale, it is actually very difficult to be disrupted. I just want to mention this point again. Thank you. Your next question comes from the line of Ella Ji from China Renaissance. Please ask your question. Thank you for taking my question and congratulations on your strong results. I just have a quick question regarding the investment cycle of JD Logistics. Understand that you now are achieving higher utilization rate of your facilities. Could you share with us what's the utilization level for now? And how long or when do you think it's time for you to start with the next round of investments as you continue to expand your business? Thank you. In terms of logistics infrastructure, since last year, we've seen making a very significant strategic investment into warehousing and transportation and terminals and Kaisa Technologies. As we've mentioned, actually, there's still room for improvement in infrastructure utilization. We can benefit by economies of scale and also we can benefit by improving our technologies. This year and also years into the future, we will continue to make more investments. Of course, terminals where we are very strong will continue to be the area we to receive our investment. We're sure through technologies, we can improve our customer experience and also size and also efficiency, which are very important to sales out for logistics company. Ladies and gentlemen, that does conclude the conference for today. Thank you for participating. You may all disconnect.