Earnings Call: Q3 2018

Nov 19, 2018

Hello, and thank you for standing by for jdys.com's Third Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen only mode. After management's prepared remarks, there will be a question and answer session. Today's conference is being recorded. If you have any objections, you may disconnect at this time. I would now like to turn the meeting over to your host for today's conference, Ruiyu Li. Thank you, operator, and welcome to our Q3 2018 earnings call. Joining me today on the call are Richard Liu, our CEO Lei Xu, our CMO and CEO of JD Mall Sidney Huang, CFO and John Liao, our Chief Strategy Officer. For today's agenda, Mr. Huang will discuss highlights for the Q3 2008. Other management will join the Q and A session. Before we continue, I refer you to the safe harbor statements in our 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 non GAAP measures to the most direct comparable GAAP measures. Finally, please note that unless otherwise stated, all the fingers mentioned during this conference call are in RMB. Now I would like to turn the call over to Simeon. Thank you, Lee, and hello, everyone. Thank you for joining us today. We are pleased to report healthy development in major financial metrics in the Q3. Our core e commerce business continued its solid performance on both the top line and bottom line, while new businesses made encouraging progress. Net revenues in the 3rd quarter grew a decent 25.1 percent year on year, in spite of slowing consumption affecting the large ticket electronics and appliances categories. General merchandise revenues continued strong momentum with over 40% in year over year growth during the quarter. Also notable is our fulfilled GMV, which grew over 30% in the 3rd quarter, supported by better long tail product performance as a result of our focus on improving marketplace operations since last year. Our fulfilled marketplace GMV grew over 40% across both electronics and general merchandise categories, as we welcomed more than 20,000 merchants to our marketplace platform this quarter. Existing merchants also enjoyed our improving ecosystem with both top tier and mid tier merchants seeing reaccelerated growth on same store sales in the quarter. We are pleased to see jd.com remains one of the most attractive platforms for merchants in China to engage with end customers. In addition, net service revenues grew 49% year on year and contributed more than 10% of our total quarterly net revenues for the first time. Supported by strong growth in advertising and JD Logistics 3rd party services. Gross margin was relatively stable year over year, thanks to the gross margin expansion from the core JD Mall business, offset by JD Logistics, which is in an investment phase, but has seen sequential improvement in unit economics over the past 3 quarters. Non GAAP gross margin in the 3rd quarter was 15.2% compared to 15.3% in the same quarter last year. If we look at JD Mall, gross margin on our direct sales business improved 15 basis points on a year over year basis on top of a very strong Q3 last year, driven by continuous increase in economies of scale across all key categories. During the Q3, we continued to invest in R and D and technology infrastructure. Our R and D expenses totaled RMB3.4 billion or 3.3 percent of total revenue, up approximately 120 basis points from the same quarter last year. For the 1st 9 months of 2018, R and D expenses increased 88% to a total of RMB8.6 billion. We believe these investments are critical to position ourselves for the next phase of growth. With the key leaders and the various teams now in place, we expect R and D expense ratio to begin to stabilize going forward. Our fulfillment expense ratio improved 20 basis points in the 3rd quarter, driven by better unit economics. Our marketing expenses ratio and G and A expense ratio was 3.9% and 1.3%, respectively, comparable to the same quarter of last year. Non GAAP operating margin was 0.6% in the 3rd quarter, compared to 1.8% last year, with the difference mostly attributable to the higher R and D expenses. Non GAAP operating margin for JD Mall was 2.2%, 3.1% lower than the same period last year. For the 1st 9 months of 2018, non GAAP operating margin of JD Mall was 1.7%, comparable to the level in the same period last year, thanks to continued improvement on our core e commerce gross margin, offset by higher R and D expenses at JD Mall. Our operating cash flow remained positive after the seasonally high Q2, while free cash flow was negative due to high CapEx during the quarter, including RMB3.6 billion in land use rights and construction of warehouses and RMB5 1,000,000,000 in IT infrastructure. As of September 30, 2018, our cash position remained strong with cash and short term liquid investments totaling RMB42.9 billion. In addition, as we communicated last quarter, we're in the process of transferring some of our logistics real estate assets into a core fund, which should help unlock the hidden value of these assets and further strengthen our cash position. Now let's discuss our financial outlook. We expect Q4 2018 net revenue growth to be between 18% 23% on a year over year basis. Our Q4 guidance reflects relatively soft certain durable goods categories, as indicated in the latest National Bureau of Statistics report. Despite slowing retail sales according to NBS data, we are encouraged by the Double 11 promotion season, where most categories showed above the industry growth rates based on our brand partners' feedbacks and third party industry reports. And our marketplace continued to grow faster during the promotion season. This concludes my prepared remarks. We will now take your questions. Thank you. The question and answer session of this conference call will start in a moment. In order to be fair to all callers who wish to ask questions, The first question is from the line of Eddie Leung from Merrill Lynch. Please go ahead. Hi, good evening. Could you comment on the macro environment, especially in the retail space? And how does it affect your monetization strategy as well as your logistic expansion plan? And then just a follow-up question on the increase in R and D investment. Could you talk a little bit about how various projects have helped your business in the past couple of quarters? Any examples and use cases that would be great. Thank you. Okay. So I will start and others may contribute later. So on the macro, I mentioned that we did see some impact on durable goods categories and but during our latest promotion season, we actually saw JD continue to lead the industry growth when we check with our brand partners. But there seems to be some impact on the big ticket size items. While for general merchandise categories, we continue to see very healthy growth rate. And in terms of impact, because we are a mass market retailer, our scale gives us unique pricing competitive advantage. So even in the economically slowing time, we do believe our value proposition with quality products, everyday low price and better services will continue to win customers. So we do not see any major impact on our overall profitability trend moving into next year. Now on the logistics investments, the type of customer experience that this service can provide is clearly showing the JD unique advantage, not only on our first party business, but as I mentioned earlier, our marketplace business has expanded faster and part of that growth is from our logistics services that are increasingly utilized by our top merchants. Just one more add. In terms of technology investment, of course, we continue to invest in retail innovation in terms of social commerce and common commerce. I think this would be the next frontier of possible growth for JD. But additionally, we mainly look into smart suppliers, smart logistics and smart consumption in terms of pushing the frontier of efficiency and cost and the customer experience as well. Understood. Thank you. Thank you for the questions. Next question comes from the line of Alicia Yap from Citi. Please go ahead. Hi, good evening management. Thanks for taking my questions. I have questions on JD initiative on this retail asset service and overall JD positioning. So could you help us understand a bit more about this platform? Which industry vertical will that specifically target? How is that service JD is offering different from the service provided by the bigger peer. And in related to that, appreciate if management could also help us redefine JD positioning. Will JD continue to sign up global brands on your platform? And since that JD is moving away from the local brands and put more focus on servicing the international brand. So any change of JD visions of being the retailer or is it JD shifting focus to become more a service provider? Thank you. Yes. Let me explain the retail as a service concept first. As I mentioned in my previous earnings call, we defined the digital retail as the boundless retail, which means the retail industry will become even more fragmented and decentralized than ever before. So in this case, JD is moving away from vertical integrated model to more open model. So in other words, in the past, the one reason why JD has become so successful is because we provide end to end solutions for retailers. So JD Mall, we have JD Logistics and so on and so forth. So moving forward, we have to open up our retail infrastructure to cover our value chain. So in other words, we wanted to provide our retail and logistics service to the other retailers as well. Meaning, if you look at a lot of retail innovations from content commerce, social commerce and so on and so forth, it is inconceivable for those retail innovators to develop those heavy assets and network based retail infrastructure. So in this case, JD really wanted to open up our retail infrastructure to enable and empower more retail innovation. So this is how we define retail as a service, which basically consists of 2 components. Number 1, of course, JD will continue to focus on retail innovation as our main focus. But at the same time, we'll open up our retail infrastructure, like logistics, like our technology to connect and enable retail innovations. So that's what we mean by retail as a service. Sorry, what about the positioning as kind of a service provider versus the traditional retailer? Yes. Of course, the retail infrastructure will become the service providers for other retailers. So we do expect, as indicated on the revenue model, the service revenue has grown significantly. This is part of the retail services strategy. Okay. All right. Thank you. Thank you for the question. Next question is from the line of Ronald Keung from Goldman Sachs. Please go ahead. Thank you. Thank you, Richard, Sydney, Xu Dong, Naodong and Ruiyu. We're pleasantly to see the 3P growth, the strong growth of 40%, which is above the industry growth over the quarter. Could you share like what categories have brought this healthy growth, particularly how did apparel perform during the quarter? And how does management see sort of the 2019 for your marketplace growth with the new e commerce law coming up in the upcoming year? Thank you. Sure. So we have seen actually growth across multiple categories on our marketplace, mainly from long tail products and long tail merchants. We added a fairly large number of new merchants now with total over 200,000 merchants on our platform. Both our electronics categories and general merchandise categories saw growth rate over 40%. So it is really part of a result of our overall platform improvement. We're also pleased to see that the general merchandise GMV as a total of our overall fulfilled GMV now surpassed 50% mark during the Q3, which is again a great validation that JD continues to become a full category platform that attracts the customers and the merchants across all the key categories. Thank you for the questions. Next question is from the line of Alex Yao from JPMorgan. Please go ahead. Hi, good evening guys. Thank you for taking my question. Can you help us understand your top strategic focus for 2019, given the macro outlook, but the emerging growth opportunities across offline, retail, logistic, etcetera, etcetera, where will you be focusing on for 2019? And then related to the how would you prioritize the financial resource allocation, I. E, in a macro consumption backdrop when your financial flexibility is relatively weaker, would you continue to invest aggressively across the new initiatives or these initiatives will slow down a little bit pending on the macro condition? Thank you. Our overall growth strategy has always been long term driven. So we'll continue to invest for various long term initiatives. However, after the last couple of years of investments, particularly for example in R and D areas, we have now have our key teams and key leaders in place. And some of our initiatives over the past 2 years have beginning to see some very positive results. So we will continue to invest for the future, while we will obviously put more discipline at the same time on our more developed, more growth business, so that there will be a very good balance in the future. We will always be mindful of the resources we have and strike a good balance of both long term growth and the near term financial results. Yes. We I think we have to have a new growth mindset moving forward in terms of 3 different balances. Number 1, a balance in the top line and the bottom line to make it more profitable. That's the first one. Number 2, to balance core business, growth business and its future business to make it more sustaining. Number 3, to balance profit, people and the place to make it more sustainable. So I think that's a new way we define our growth mindset. Thank you for the questions. Next question comes from the line of Jerry Liu from UBS. Please go ahead. Thank you. Sydney and John, from your comments so far on this call, I'm hearing about logistics unit economics improving, R and D expense ratios stabilizing, no macro impact on profitability trends and just now talking about balancing top line and bottom line. So despite year to date net margins being lower this year than last year, I'm hearing a lot of things that suggest maybe net margins can stabilize or improve as we head into next year. Is that the right read? Thanks. Sure. Yes, we have maintained that on a long term basis, our margin should gradually improve. So this year, because of JD Logistics, was in the investing year. So on my last earnings call, we mentioned that this year will be more making sure that JD Mall will maintain a stable margin trend with some upside. But if you look at from a couple more years or from last year to next year, we do see the margin continue to gradually improve. Obviously, there will be some of the other new business lines like I mentioned JD Logistics Real Estate Business as part of the contribution as well. So overall, we do intend to have the full intention to grow the business, investing for the long term, while gradually improving the bottom line. Got you. Thank you. Thank you for the questions. Next question is from the line of Thomas Chong from Credit Suisse. I have two questions. My first question is about the customer growth during the quarter. We are seeing negative sequential growth. Can management explain about the reason and how we should think about the trend going forward? And my second question is about our CapEx. How should we think about the CapEx in 2019 2020 as a percentage of revenue, if there's any? Thank you. Yes. I'll take the CapEx question first and Shilei will take on the user question. So for CapEx, this year is definitely a very heavy CapEx investment year, partly driven by our logistics warehousing build out and partly is because of IT infrastructure, but both of which we hope will complete the heaviest investing phase this year. And there should be somewhat of a moderating trend moving into next year. Let me take the question about users. As the economy slows down and in the light of JD dotcom having already more than 100,000,000,000 users, I think at this particular stage, we need to focus more on the quality of growth, quality of users. As our logistics network penetrates into the lower tier cities, we have recently started to step up our marketing efforts towards those areas. And also we find it's very effective to attract new users, particularly lower tier users and female users through initiatives in the area for decentralized and non open shelf models like group buying, mini programs and Tesla, etcetera. Some categories enjoy ample room for growth offline, especially in lower tier cities. To capture this opportunity, we will integrate online with offline operations, come up with new product models and create new offline setting scenarios. And Roger, I'd like to add 2 more points. One is that we find there are plenty of middle income and low income people in 1st and second tier cities. We have extensive market penetration and brand awareness. So we will tap into that segment too. We will also work to boost our retention rate and average revenue per user by enhancing our cross category penetration. Thank you. Thank you for the questions. I will now go on to the next question from Grace Chen from Morgan Stanley. Please go ahead. Ms. Grace Chen from Morgan Stanley, your now is open. You may unmute locally. We'll move on to our next questions from the line of Jin Yoon from New Street Research. Please go ahead. Hey guys, thanks for taking my question. Fini, in your prepared remarks, you talked about strength in advertising. Can you just talk about the drivers behind that in the quarter? Any potential structural meaningful changes you have seen in the recent quarter as well? Thanks. Let me take the question. The consumers' growth in our advertising income is mainly due to the optimization of algorithm and the improvement in technology capacity. Our eCPM is a constant rise. Since JD's retail business includes both direct sales and marketplace platform, we will balance advertising income with user experience. Also, in the utilization of traffic, we will try to strike a balance between retail sales and advertising monetization. As our algorithm optimized, we have changed the composition of our advertising products, cutting down on CPD and jacking up RTB. However, our advertising income has still maintained very good growth momentum. We aim to get win win situation with both ad monetization and merchant satisfaction. Thank you for the questions. I will now move on to the next question from James Lee from Mizuho Securities. Please go ahead. Yes, thanks for taking my question. And this question is for Richard specifically. Maybe can you help us understand how your role would be changed at the firm going forward, given that a new leadership team has been put in place? And what is your key focus going forward? And what business segment will you be focusing on personally? Thanks. As you correctly pointed out, the leadership team of JD has already been put in place and is doing very steady for the job. For me personally, I will focus more on new businesses. For mature businesses, our team can handle that. Since some friends have raised a question about our growth strategy for next year, so I'd like to take this opportunity to say a few words about that. As we've just mentioned, our R and D expenditure for the 1st 9 months from January to September experienced a growth of 88% year on year. And that number actually hasn't included Jindongsu D expenditure. We have started a lot of new R and D projects and also we encourage competition across among different R and D teams. For example, store based technology, we encourage them to compete. In the past year, we've tried out in many ways and now actually we can see the future, see the direction very clearly. So we are now deploying our teams to the right R and D projects, to the right direction. So for next year, the total amount of R and D expenditure might not increase, will not grow. At the same time, the net profitability of JD Logistics will boost a lot. So I do think next year our net profit performance will be better than this year. In terms of growth of customers will grow faster than industrial average to gain more market share. Just in terms of cash flow, this year, the land rights cost and logistics investment becoming this year. So put our cash flow position into quite a strong pressure. But next year, a severe pressure, next year, I do see we will improve a lot in this area. In the nutshell, next year, we will grow much higher than the investor average and we will improve our gross profit and also net profit. And with this consistent investment in RMB for Ximeni Yexai, Do you think next year we can get the result? We will do better in technology income. For me, I personally focus on 4 things. 1 is strategy, this culture, then team and then new businesses. Thank you. I will continue with the next question from Wendy Huang from Macquarie. Please go ahead. Thank you. I just have two quick questions. One is on the competitive landscape in the logistics space. So on one hand, you are expanding aggressively into 3rd party logistics with several initiatives in past few quarters. But on the other hand, we also know that for example, they are fighting back and listening to they set to build a large automatic sorting center in Xunghi as well. So maybe if you can give any color on that will be great. And secondly, since Richard is on the call, I just wonder if you can give us any update on the allegation against the personal case. Thank you. Okay. So on the logistics, as we mentioned in the past, JD Logistics has built an unrivaled infrastructure by serving our own first party e commerce business and along the way earned great customer very, very good service quality over the years. So and as we continue to implement our retail infrastructure strategy, retail as a service strategy, we have seen merchants actually and the brands came to us to provide similar logistics services to these 3rd party partners. So this has been a theme that we mentioned since earlier of this year. And obviously, with the sales growth this year at a triple digit for the past several quarters, Clearly, there are very unique value being provided by the JD Logistics. And on your second question, I just want to answer that we really do not have any new information to share with you. And honestly, we cannot further comment because it is important that we respect the due process of the U. S. Justice system. As you see, Lucia has been back to work as usual in the company and this situation that did not and is not expected to have any material impact on JD state operations. Our strong senior leadership team with most of its members having spent 5 to 10 years with the company continues to effectively guide our company towards its goal to grow our business and serve our customers. So as the purpose of today's call is to discuss our earnings results, So we would appreciate your limiting further questions to this topic. Thank you. Thank you, Hong. The next question is from Jialong Shi from Nomura. Please go ahead. Good evening, management. Thanks for taking my call. I will ask my question in Chinese, then I will translate into English myself. I have two questions. My first question is about 7 Fresh. I just wonder what management store open plan under 7 Fresh initiative and whether or not 7 Fresh will be accounted as part of JD Mall? And how should we assess the margin impact from 7 Fresh for this year and the next year? And for JD Logistics and I just wonder if management can provide an update on the progress of capitalizing the JD Logistics some of JD Logistics Resources, which CFO mentioned on last quarterly call. And I just wonder how should we assess the margin impact from this initiative? Thank you. Sure. So for 7 Fresh, we expect in aggregate a dozen or so stores by end of this year and probably another 20 plus stores in the first half of next year. Now because we want to be expand the business in a prudent manner, we're actually opening the stores in a very careful and be well prepared for all the initial preparations. So in terms of impact on the margins, we do not expect any material impact on our overall margin. And for the current performance of the existing stores, we are actually pretty comfortable that on a single store basis, the margin should be breakeven and turn positive in a relatively short period of time. And for the logistics assets, we are transferring some of the existing assets into a core fund. And we've received very good initial investor interest, very good indication. We still expect that transaction to happen in the first half of next year. Thank you. Next question comes from the line of Natalie Wu from CICC. Please go ahead. Hi, good evening. Thanks for taking my question. Just wondering for the contract with Tencent regarding the Weixin level 1 access point to be terminated next year. Can management update us the following renewal progress? Thank you. And of course, since the Tencent investment in JD, we have been collaborating really well in a number of fronts in terms of investment, in terms of offline retailing, such as Gugao and HaiLanzuzia, right, and I think for the next level of collaboration, of course, we will expand the from basic gateway access to multiple fronts, such as social commerce and to be business as well. So right now, we are continuing our discussion and we shall have more update in the near future. Thank you. Thank you for the questions. Next question is from the line of Tian Hou from TH Capital. Please go ahead. Yes. Good evening, management. The question is related to the category expansion. So as Sidney mentioned, general merchandise the first time went about 50%. I remember since today JD becomes a top of this company, this has been the goal and seems like the finally will accomplish that. And however, given the fact that cell phones and home appliances facing some headwinds, what's the company's strategy in expanding in other categories rapidly to really offset the headlines in other 2 major categories. Yes, sure. So as we mentioned in the past, JD as a platform has 1st in the overall marketplace operations, improving merchant experience, we talked about for some time. And also from our overall strategic planning point of view, as John mentioned last time that we in addition to growing our more established business, we have been also investing in some of the so called 100,000,000,000 club into some of the new categories. So it's really a result of all of these efforts that helped us expand our general merchandise categories. So we did mention some of the categories in the past. Obviously, our home products, FMCG, fresh products, also our a number of other ones that we mentioned along the years, because when you look at these categories, we do see fairly consistent growth across all of these categories. So it is really the power of the overall platform rather than any particular focus on just one of them. Thank you for the questions. Next question is from the line of Binnie Wong from HSBC. My first question is on the Retail as a Service strategy. So I think in the last few quarters, we have been saying that we have been gaining traction as we open up to a wide range of partners. So can management update has shared with us any progress update in terms of like the number of partners or any use cases of how our strategy has improved the productivity for our retail partners? And also updates on any monetization strategy in this area would be very helpful. And my second question is a follow-up on the growth strategy, right, because we I think management has mentioned that the decline in the annual active customers this quarter was because we want to focus on the quality. So we of course see the GMV per customer has been improving. So just want to see that focus. Is it mainly like the driver for the GMV increase like the quality customer? Is it mainly from the consumption upgrade or is it because that we the customers are buying more categories? So how should we think of that? And second to that is that on the loyalty program, because we see good progress, right, on the premium membership, how much higher is the users that have the premium membership? How much bigger basket size are they buying versus those that do not have this premium membership? Thank you. Yes. So we'll try to limit 2 questions each person. I'll try to answer the first one and then Xu Lei can answer on the Plus membership program. So for the 2B business, I mentioned, 1st, our service revenue has surpassed 10% of total revenue for the full time. So a lot of that is happening, obviously, namely with JD Logistics is one of them. But also on our mini program on the we call it Project Kepler internally, as Sheila mentioned earlier, these are all also generating meaningful progress for our merchants, brands and also for our customers and the partners. So some of these are in terms of revenue contributions, it's still small, but clearly, we are gaining traction in these areas. In the 3rd quarter, plus members have exceeded RMB10 1,000,000. These are our core users with the strongest purchasing power, performing great in terms of buying frequency and average revenue per user app. We will continue to optimize and invest in membership benefits with more and more brands and partners coming aware of the value of those plus members. Co membership and value added service will be our focus for the next stage. Our co membership project with iQIYI has been doing very well. We'll look at expanding from videos to travel to entertainment, catering, knowledge for fans, etcetera. Etcetera. That's it. Thank you. Our next question is from the line of Susanna Choi from RBS. Please go ahead. Hey, hello. Good evening. Thank you for taking my question. Could management update the 7 flash operating data, for example, the sales per square meter versus the traditional supermarket and the online order contributions? And could management share how your linked retail strategy differentiate from the competitors? Thanks. Yes. On 7 Fresh, because the current scale is still relatively small, but I did mention last quarter that sales per square meters is roughly 3x, 4x of the traditional offline retail sales figures. Sorry, I lost the second question. What's the second question again? Yes, sure. I would like to management to share how your new retail strategy differentiate with your other competitors? I think in one sentence, I think we're moving in I mean because we look at the reach of the future in a different way. As such, we have a different strategy. From JD standpoint, we move from a vertical integrated model to become an open model. And comparatively speaking, our competition is moving from an open model to become more vertically integrated model. So let's assume what we're putting. Thank you. Next question is from the line of Hans Chung from KeyBanc Capital. Please go ahead. Good evening, management team. Thank you for taking my questions. So I have a question regarding the JD Logistics and the management team mentioned earlier the profitability will improve a lot next year. So I just want to know is this driven by that like pricing or new customer growth or the cost reduction initiatives? And then follow-up is when we'll start to see the logistics start to breakeven? Thank you. Yes. So it's actually from multiple areas. As we mentioned, because it was the initial year, we did expand capacities at the beginning so that we can have ample capacity to serve the new customers very well. So initially, there was some overcapacity. That was one initial reason. 2 is that we offered discounted trial period for the customers to try out our services. Part of the reason for that is our supply chain management services involving the integrated warehouse and delivery service. So for the warehousing part, there is a natural kind of start up cost because the merchants and brands tend to have their own warehouses, existing warehouses. So any migration to our service may incur initial incremental cost. So our initial trial period essentially lowered the barrier for this initial service period. And as we move past those initial periods, obviously also with the capacity warehouse capacity better utilized, loss ratio will gradually shrink. So that's actually a fairly natural outcome after the initial investing phase. So for the Q3, which is actually a seasonally low quarter, we were very pleased to see continued narrowing on loss ratio, because the business volume still grew on a sequential basis for this particular business, which continue to have better improving the utilization for our overall capacity. Thank you. We are now approaching the end of the conference call. I will now turn the call over to JDs.com, Ruiyu Li for closing remarks. Thanks, operator, and thank you, everyone, for joining us today. Please feel free to contact us if you have any further questions. We look forward to talking with you in the coming months. Thanks. Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.