Earnings Call: Q3 2017

Nov 13, 2017

Hello and thank you for standing by for jds.com's 3rd Quarter 2017 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 mic over to your host for today's conference, Ms. Ruiyu. Ms. Ma'am, please go ahead. Thank you, operator, and welcome to our Q3 2017 earnings call. Joining today on the call are Richard Liu, our CEO and Sidney Huang, our CFO. For today's agenda, Mr. Huang will discuss highlights for the Q3 2017. Following the prepared remarks, Mr. Liu and Mr. Huang will answer your questions. Before we continue, I refer you to our safe harbor statement 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 non GAAP measures to the most directly comparable GAAP measures. Finally, please note that otherwise stated, all figures mentioned during this conference call are in RMB. Now I would like to turn the call over to Sidney. Thank you, Ruiyi. Hello, everyone. Thank you for joining us today. We are pleased to report another quarter of solid top line growth and record profitability. During the Q3 2017, our net revenue from continuing operations grew 39.2%, a solid performance following an exceptionally strong second quarter. Our deluxe sales revenues grew 38%, led by home appliance, food and beverage, cosmetics, home furnishing and baby products. General merchandise categories as a whole grew 67% in revenue on a year over year basis despite the intense competition in these categories. Our revenues from services and others increased 46% year over year, an acceleration from the growth rate in the seasonally similar Q1 of 2017, supported by improved brand engagement and better monetization of our platform. Some of you may have noticed that we moved our GMV disclosure to the back of the earnings release and are using just one instead of 2 different definitions for this non GAAP metric. As you may recall, we began to disclose 2 sets of GMV numbers since the Q4 of 2015 in order to provide an apples to apples comparison to our major industry peer, while maintaining our original definition in parallel for investors' convenience. Over the past 2 years, we see continued confusion over these different definitions. So we decided to simplify it beginning this quarter. Since the industry definition is broader with many unfulfilled orders in the numbers, we will not further analyze such GMV figures, which are provided for industry comparison only and should not be relied on for financial analysis purposes. However, we will provide we'll continue to provide qualitative analysis on our GMV trend based on the underlying transactions actually fulfilled. For the Q3 of 2017, the fulfilled GMV grew in the low 30s, mainly attributable to 2 factors. 1st, the anniversary effect of integrating the E haodian platform, without which the GMV growth rate for JD Mall would be in the mid-30s. 2nd, the impact from certain apparel and general merchandise merchants withdrawing from our platform. Based on the feedbacks we received from these merchants, the move was mainly due to the cohesive tactics from our competition, which if proven true, would be illegal and clearly against the merchants' will. Despite this short term headwind, we are pleased to see a very successful November 11 promotion season, which demonstrated the resilience of JD's powerful platform. We are also pleased to report very healthy gross margin expansion in the 3rd quarter, which reached a record high of 15.3% on a non GAAP basis. Non GAAP gross profit after fulfillment expenses, another important measure of our platform monetization, grew 64% on a year over year basis as we gained further economies of scale from procurement, merchant services and fulfillment network. Our collaborations with leading platforms such as Tencent, Baidu, NetEase, Qihu and Toutiao have shown exciting early results as we provide better positioned marketing tools to our merchants and brands to enhance ROI on their advertising spending, while reaching a broad customer base on multiple platforms. Leveraging in house AI technologies, our real time bidding advertising platform has generated triple digit revenue growth in the past three quarters and is now contributing a significant majority of our advertising revenue. During the Q3, we continued to invest proactively in logistics, branding and technologies. Non GAAP fulfillment expense ratio increased 11 basis points from the same quarter last year as we significantly expanded our warehouse network during the quarter to better serve our merchants and to prepare for the November promotional season. At the end of September, we had 4 5 warehouses nationwide with approximately 9,000,000 square meters in total space, up over 50% from 12 months ago. Non GAAP marketing expense ratio was 3.5% in Q3, higher than the 3% in the same quarter last year as we continued to increase our branding efforts to reach consumers in the lower tier cities. In spite of heavy investments for our future expansion, we are pleasantly surprised by another quarter of record earnings. Non GAAP operating profits increased 171 percent to a record high of RMB1.5 billion in the 3rd quarter. Non GAAP net income attributable to ordinary shareholders was RMB2.2 billion with an increase of 3 59% on a year over year basis. And our GAAP net income attributable to ordinary shareholders was RMB1 1,000,000,000, also a record high with a healthy net margin of 1.2%. The result speaks for itself and provides a strong validation of JD's underlying earnings momentum. Our free cash flow was negative RMB9 1,000,000,000 during the quarter, mainly due to two reasons. One is the RMB5.2 billion inventory buildup for the November 11 promotion season, which is largely a timing issue and 2 is the much anticipated CapEx, including RMB4.4 billion in new building in new land use rights for more headquarters, space and the new warehouses. As we communicated in the past, we normally acquire land use rights at a very attractive economic terms given our contribution to the local economies. We expect such CapEx to be highly accretive to our shareholders. Even with the cash outflow in the Q3, our cash position remained very strong. As of September 30, 2017, cash and short term investments, mainly in money market funds, totaled RMB41.8 billion, up 71% from RMB24.4 billion at the end of last year. Now let's discuss our financial outlook. We expect Q4 net revenue growth to be between 35% and 39% on a year over year basis, excluding any impact on JD Finance for both current and prior year period. This concludes my prepared remarks, and we can now move to the Q and A session. Our first question comes from the line of Eddie Leung from Merrill Lynch. Please ask your question. Good evening. Thank you for taking my questions. I have a question on the product mix you are selling because we left off from the 2011 press releases actually not press releases, but some of your colleagues actually provided certain colors to the media. It seems like there has been an upgrade in quite some of the product categories. For example, we have seen your high end products are selling at triple digits growth rates. So wondering how that could affect our margins going forward? Thank you. So I assume you're referring to some of the brand cap higher level brands in general merchandise category, they obviously have very healthy margins. This is also a result of our efforts this year to reach out to global brands. And because the overall contribution of those brands are still relatively small, While the impact will be positive, but it will not be very material in the near term. Got it. Stuart, may I have a follow-up on that front? Are we sticking to our previous full year margin guidance? Yes. We would try to stay away from any single quarter guidance on the bottom line. So because this is the last quarter of the year, so we would try to stay away from any further guidance. Understood. Thank you. You're welcome. Thank you. Our next question comes from the line of Alicia Yap from Citigroup. Please ask the question. Hi, good evening, Richard, Cindy and Rui Yi. Thanks for taking my questions. I actually have a follow-up questions related to margins and specifically on the gross margin this quarter. So it does look like the strength is coming from the 1P business. And just curious, is it driven by slow season that, hence, you don't have a lot of promotion? Or is that driven by the change of category mix like Eddie mentioned? And then in related to that, since you are retaining your full year guidance, your net margins on 1% to 1.5%, you are not changing it. But with the outperformance in the 3Q margins, if this is the case that you're retaining your full year margin, should we assume that 4Q net margins will be a much bigger sequential decline versus the 3Q? Any color you could provide us to think about the margin directions or assumptions for 4Q would be great. Sure. So for the gross margin question, I think there are three reasons. One is from our first party business, the scale economies has been driving our procurement costs coming down on a consistent basis. So that has always been part of the contribution, as I mentioned in the past. And the second is that I mentioned earlier about our enhanced user engagement, also the brand engagement through better advertising products, monetization has improved for our overall platform. So really those are the 2 key drivers. Clearly, without major promotions in the 3rd quarter would also contribute to the sequential increase in the gross margin. So related to that, to come back to your question on Q4, I think if you I wouldn't guide for any single quarter, but if you want to take a benchmark, you should probably benchmark to the Q2 when we had also a very major promotion to the 4th quarter rather than comparing to the 3rd quarter. But again, we are not providing any guidance on the bottom line for any single quarter. So over the long term, our commitment is to improve our profitability on an annual basis. And with that in mind, we do not manage earnings on a quarterly basis. And if any certain quarter has outsized profitability, we may decide to reinvest part of that excess return back into the business to pursue further growth. So that strategy has not changed. We do not intend to pursue very large outsized increase in net margin for any single year, but we want to make sure that margin will increase steadily over a very, very long period of time. Yes. So if you look at it over the long term, any excess return beyond our expectations will be reinvested roughly 30% to 40% of those excess returns back into the business and half of that will be in technologies. Thank you. Our next question comes from the line of Ronald Keung from Goldman Sachs. Please ask your question. Thank you, Richard, Sydney and Rainyu on a very strong set of results. I think on the 3P revenue, and as Sydney, you've mentioned, it's very strong 67%. That makes me think about the 3P business given the challenges in the apparel brand. Can you just share how the merchant number, which you've seen a massive increase on a quarter on quarter basis, 260,000 merchants? If we think about apparel and other marketplace merchants by category, can you say just a strategy from now on given the exclusive contracts or competition that we've seen? What is the strategy into in our marketplace business? And specifically for apparel moving to high end with top line. So I just want to share, hear your thoughts on the 3P business and by category. Thank you. So let me quickly translate. You may have heard from the media that we are experiencing some headwinds. Over 100 merchants in the general merchandise category has withdrawn from our platform due to certain competition practice in the markets and leading to some of the merchants going to one platform rather than going to both. So those brands are all of them are Chinese brands. They are relatively smaller. And so it's we actually haven't seen any large global brands in this way. So we have, throughout our history, experienced many of these competition where our competitor would force the merchants to choose 1 out of 2 platforms almost every 2 to 3 years. In the earliest days that our digital IT products, we faced these competition and then later was in the books and the media segment for 2 years. And then in the home appliance with our major competitors for almost 3 years. And we've overcome all those competitive pressures and have become the largest category leader in all of these categories. So today, out of the 14 major categories, we are the leader in 12 of them and with only 2 remaining. So we do believe that while this is not the first time we're facing this kind of competition, this should be the last time. So the key for us to overcome the competition was because we have always worked very hard to help our brands to grow and help our brand partners to make profit and in return would also help us to grow with these brands. So today, maybe in the apparel segment, we are only onethree to onethree of our major competitors' size. But over time, if you actually check with these brands, the brand's profitability on JD's net profitability on JD's platform may not be actually any less than their profits on the larger platform. So throughout our history, every in any category and every category, we always encountered this competitive tactic. And it's almost inevitable, but it's also it can always be overcome. And so we believe this is the last category. And the fact that we are facing this competitive tactic again is also suggesting the competition may be running out of it's really the last resort in terms of competitive tactics. Another interesting fact that for the global brands that stayed on our platform during the most recent November 11 promotion, All of them grew over 200% and which really validated the power of the platform. Another point I want to add is that over the past few quarters, the categories which are mostly targeting female customers are growing the fastest. All of them have been growing in a relatively in an accelerating fashion. And this demonstrates really our even though our current quarter actually even though our current quarter actually saw stagnant growth in apparel category and which could also last 2 to 3 quarters, but we're confident that past beyond the next 2 to 3 quarters, we will see growth resume again and just as we saw in other categories reach inflection point. When we have more and more female consumers on our platform, the growth from the apparel segment will be almost inevitable. Thank you. Our next question comes from the line of Jerry Liu from UBS. Please ask your question. Hey, thank you. My question is relating to the cash flow statement. Then you wanted to get your view on cash conversion cycle and how quickly that can improve without JD Finance and whether as you gain scale economies of scale, you can see further improvements even excluding this benefit from the financing business? Thank you very much. Well, there's no impact on JD Finance at all. As I mentioned earlier, the cash flow negative cash flow this quarter was one is the timing issue for inventory buildup. We did stock up a higher inventory level than the prior year as we focus trying to overcome some of the merchant withdrawing from our platform. So we revert to the 1st party for those products. So this is really a timing issue post November 11. And also in December, there may be another promotion, then the inventory will be digested. And another factor was the CapEx, right? So none of these are related to JD Finance. In fact, we are supporting JD Finance, not the other way around. So on a full year basis, you can be assured that our free cash flow will always be positive from JD Moore alone. In fact, if you look at the last 12 months, the free cash flow was still very, very strong. Thank you. Our next question comes from the line of Grace Chen from Morgan Stanley. Please ask your question. Hi, thank you for taking my call. We can see that JD has been doing very good margin improvement, but at the same time, we also see that you are accelerating investments as well. I think Richard just mentioned that JD in general will reinvest the excess return, 30 point percent of the excess return and half that will be in technology. But as you can see, we have many other investments, including we're investing in FMCG, branding, logistics, overseas expansion as well. So what would be the priority of these other investments? And also can you help us rank them when the spare investments in terms of size? Thank you. Yes. So most of the items you mentioned earlier are actually part of our regular businesses, so which will see continued investments. What Richard mentioned earlier was any excess return beyond that and we will reinvest part of that. And technology will be the most important element for those reinvestments. Thank you. Our next question comes from the line of Jim Yoon from Mizuho Securities. Please ask your question. Hi, good evening guys. Sidney, the 100 merchants or so that left the platform or allegedly left the platform, is that a net number or gross number of additional merchants that you have added on during that period? And second of all, on the just going back to the CapEx, are we pretty much done with the CapEx spending for this calendar year? Or should some of that land rights investment should that trickle into the Q4 as well? So for the 100 plus merchants that left the platform, essentially, they actually they are the ones close the shops, at least for the recent promotion period. So it is there's no consideration on the new ones. So these shops had a specific act of closing the shops at all in a very short period of time. So this is clearly by no coincidence, and they are all major domestic apparel brands. So all around the same time. On the CapEx, we clearly, there won't be as much in the 4th quarter, but we as I said, if we do get invest in new land use rights, we normally get them at very attractive economic terms. So it is something that's very good for our shareholders. Just to reiterate that point that we could always turn around and get a third party to pay a much higher dollar amount for those and we can lease them back. So they can be easily monetized. And it is actually very scarce resources that only JD and very, very good real economy companies can have the privilege to acquire them. Thank you. Our next question comes from Natalie Wu from CICC. Please ask your question. Hi, management. Thanks for taking my question. Richard, you just mentioned that as long as the net profit margin to be improved at a similar level of scale every year. So you are happy to invest extra money into the R and D growth, etcetera. So can it be interpreted as margin guidance, let's say, next year to be 1% higher than this year? So I can promise you that net margin would increase every year. But as I said earlier that we can't give you more specific guidance, but improvement should be meaningful. Great. Thank you. Thank you. Our next question comes from the line of Cheung from HSBC. Please ask your question. Good evening. Thanks so much for taking my question. I wonder if you can comment a little bit on your M and A strategy, both internationally and domestically. I know you've been exploring expansion in ASEAN. And sort of domestically, what is your appetite for consolidation to increase your market share? Thank you. So we are as we mentioned in the past, we are taking quite conservative approach in terms of international expansion. We had an earlier joint venture with a partner in Indonesia, and we also recently announced a partnership with Thailand Central Group. In both cases, we have similar equity interest with our joint venture partners. And the rationale is that we wanted to leverage our technology and e commerce know how and then at the same time leverage local partners, local expertise and their local consumer insights. So it is a relatively conservative and but also we believe a very effective way to expand in the international market. And at this point, our focus is in Southeast Asia. Until we gain some valuable experience, so we will pretty much stick to this region. For domestic investments, it's been also quite consistent that we wanted to invest in the companies in our ecosystem where we can create the synergies between us and investees. So we obviously have a great channel, distribution channel. We are also developing our technologies to empower other partners. So some of the second investments could be also in technologies. So not only from an in house R and D development point of view, but we would also take a minority stake in other leading technology companies so that we could leverage their technology as well. Thank you. Our next question comes from Alex Yao from JPMorgan. Please ask the question. Hi, good morning and good evening, everyone. Thank you for taking my question. I have a question regarding the customer growth. You guys grew the customer base by 34% this quarter, actually in the past 12 months. I'm just wondering, can you share with us what is the key driver for the user growth? Is it the first mile effort? Is it the price of subsidy? Or is it more because category expansion into female oriented categories such as FMCG? And also, I would like to hear update in terms of traffic contribution from Tencent. Was there anything that you guys can do such as data exchange, product integration, etcetera, to drive more user growth from Tencent's social platforms? And how should we think about the user growth trend in the next couple of quarters? Thank you. So really 2 customer segments we're seeing the greatest growth. 1 is female customers and 2 is customers from the lower tier cities. So these are also the 2 segments where JD was historically having a lower penetration and we've been making a lot of efforts to increase our penetration and we've seen very encouraging results in the recent quarters. So we've had a very, very good partnership with Tencent over the past 3 years. We are seeing the relationship deepening and more recently we are also planning to expand our partnership, not only online, but also to offline where we can create synergies between the 2 countries. Thank you. Our next question comes from the line of Xu Xia Wang, Nomura Securities. Please ask your question. I will translate the questions into English myself. I have two questions here. And my first question is, I just wonder if there will be any changes in the terms of the new business agreement JD will renew with Tencent next year. My second question is, Richard, the management mentioned earlier they expect the power business to recover from 1Q next year. So I just wonder what strategies management may have to turn around the apparel business? Thank you. Yes. So first, our agreement with Tencent will not expire until 2019. So it's still quite early before we start discussion with Tencent. In getting new support. And if we can reach agreement, that will be great. If not, we'll also have great options. So maybe the type of collaboration could be different, but we are very certain that the 2 companies will cooperate closely together. Yes. So in terms of apparel, obviously, this is in the midst of intense competition. So for trade, For confidentiality reasons, we would rather not share anything further at this point. But if you look at our promises in the past 10 plus years, all of our promises would always realize in the end. Thank you. Our next question comes from the line of John Choi from Daiwa. Please ask your question. Good evening and thanks for taking my question. I had a question on your others on services and others revenue. Could you give us some more color, especially given that the 3rd party GMV might have slowed down quite a bit this quarter? So should we assume that advertising revenue and logistics revenue have done a bit more this quarter? Any color will be appreciated. And secondly, if you just give us, could let us know the current status or the relationship with Walmart given that it's been about a year since the e housing deal. So where have you guys achieved? How do you think this relationship will evolve into? Thank you. Yes. So on the service revenue, as I mentioned earlier, advertising revenue definitely led the growth in the category followed by logistics. And so the business has been growing overall at a pretty healthy rate. So advertising is really the standout within that service revenue category. As far as Walmart, we mentioned in the earnings release that we actually one of the recent initiative is to promote a joint membership between JD Plus and Sam's Club membership. So we definitely this is just one example. We're definitely seeing a lot more collaboration going on between the 2 corporations and there will be a lot more exciting news in the near future. So we are exploring additional collaboration in our online offline Yes. So another point I wanted to add is even though we're facing some headwinds for the apparel category, we may lose some commissions and GMV. But because our platform continues to offer many different kinds of value to the merchants. So you actually see these merchants still utilizing JD platform for other services such as advertising and marketing services. Yes. So we have in the most recent quarter, 2,000,000,000 active customers, and these are all very, very valuable middle class and upper middle class consumers. So it definitely creates a great platform for the brands and the merchants. Any smart merchants would clearly not walk away from our platform in the long over extended periods. Not only a smarter merchant, also still be able to find. Thank you. Our next question is from the line of Wendy Huang, Macquarie. Please ask your question. Thank you. I have two questions. First, just to follow-up on Richard's comment about the female users and also penetration into the low tier cities. Can you give us a breakdown of your 2 60,000,000 customers by genders as well as the different tier cities? My second question is about JD's B2B strategy. I noticed that in the past 1 year, there have been a lot of players in the market start to revamp their B2B product to connect with 100 of 1000 of mom and pop shops in China. For example, Alibaba has Ling Shotong and Bass is also doing Simba Cell SARD also launched a B2B sourcing platform. And JD, I think, also has a product called Zhanggui Bao. So can you share with us about your thinking behind your BTG strategy and also what's involving JD's competitive Rangshi industry card? Thank you. Yes. So let me answer the second question first. We do have a new business unit called Xintonglu and the app is Zhongui Ba. So we are targeting the mom and pop shops. And we've now opened over 10,000 of them with JD Brand. And on the single sale alone, we opened 1111 new stores on one single day. So we have 2 key competitive advantages. First is our supply chain resources because many of the suppliers to the convenience stores are already our biggest partners such as P&G. So we will help these brand partners to penetrate and reach those convenience stores as part of their channel expansion. The second advantage is our logistics network. By the end of this year, we are already covering 100% of the provinces and countries, and we can also serve even the rural areas. Yes. So because we already have our own logistics network extending to every counties and every villages. So in order to serve the convenience stores in those regions, there's no incremental cost to us. So without the existing logistics network, any third party, any other place who wanted to reach these stores in the rural areas will be highly, highly costly. And on the users, we don't disclose specific breakdowns, but what we can tell you is our female customers has been growing much faster than male customers and also the lower tier city customers have been outgrowing the Tier 1, Tier 2 cities. Thank you. Our next question comes from the line of Thomas Chong from Credit Suisse. Please ask your question. Hi. Thanks management for taking my questions. I have a quick question about JB Logistics. Can management give us some update about the business outlook given we see our competitor also steps up in their logistics business over the next couple of years? And how we can differentiate from our peers? Thanks. Yes. So as you know, JD's logistics network is fully integrated, covering all the steps and processes in the logistics workflow. So we've built that over the past 10 years. Yes. So we'll have 3 ways to improve our logistic network. 1st is to increase order numbers so that we can further enhance order density and efficiency. So second is that we will make a great effort to expand our business serving 3rd party merchants and partners. So our objective is in 5 years, the external revenue will be above 50% of the total logistics revenue. So within the last two quarters, we already attracted over 100 major brands into our logistics platform. Yes. So in addition to the service level and grid coverage, we'll also innovate constantly in our logistics capability. One example is that we extended our coaching logistic capabilities and for products that require cold chain storage, we actually we can monitor the whole delivery process, the temperature of the products so that consumers can actually track those fresh products involved to their home. So you can see the temperature movement throughout the delivery process. It will also expand the same city delivery services through our partner, New As we extend our partnership with Tencent towards offline retail network, we believe that in the future, maybe half of the products will be available in the same city from the merchants and retailers and the same city delivery network will be very critical to provide those services. Yes. So we have also launched the first ever online sortation center covering the full sortation process without any single man. So this is definitely one of the first of its kind in the world. We've also had 170,000 testing hours for our drone delivery service And also in roughly 100 universities, we have tested our automated delivery robots. So all of these great innovations will put us clearly as a leader in modern innovative logistics solution provider. So another fact that I wanted to mention is that our automated self driving trucks, we have tested that for 500 kilometers, we only need human intervention 2 times, right? Less than 2 times. Our next question comes from the line of Alvin Jiang from Deutsche Bank. Please ask the question. Hi, good evening management. Thank you for taking my questions. We noticed JD has announced a series of cooperations with other Internet companies in addition to claims that Baidu like NetEase. So my question is what's the underlying view as you do that? And how's our expectation on these corporations? Thank you. Yes. So one of the key objectives of those partnerships is to leverage each other's unique consumer insight and unique consumer data to provide much better target marketing for our brands. So that's one of the reasons. And clearly, too, is that all these platforms have their own very large user base. So it also help us reach a broader consumer base. We are now approaching the end of the conference call. I will now turn the call over to JV Stockholm's Ruiyi Li for closing remarks. Thank you for joining us today. Please feel free to contact us if you have any further options. Thank you for your continued support and looking forward to speaking with you in the future. Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect.