京東 (JD) 2017 Q3 法說會逐字稿

Hello, and thank you for standing by for JD.com Third Quarter 2017 Earnings Conference Call.

(Operator Instructions) 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, Ms. Ruiyu Li.

Thank you.

Please go ahead.

Thank you, operator, and welcome to our Q3 2017 earnings call.

Joining me 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 third quarter 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 unless otherwise stated, all figures mentioned during this call conference call are in RMB.

Now I would like to turn the call over to Sidney.

Thank you, Li.

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 third quarter 2017, our net revenue from continuing operations grew 39.2%, a solid performance following an exceptionally strong second quarter.

Our direct 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 first quarter 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 1 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 fourth quarter 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 decide 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 third quarter of 2017, the fulfilled GMV grew in the low 30s, mainly attributable to 2 factors: first, the anniversary effect of integrating the Yihaodian platform, without which the GMV growth rate for JD Mall would be in the mid-30s; second, 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 coercive tactics from our competition, which, if proven true, would be illegal and clearly against the merchant's 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 third 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 economics -- economies of scale from procurement, merchant services and fulfillment network.

Our collaborations with leading platforms such as Tencent, Baidu, NetEase, Qihoo 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 3 quarters and is now contributing a significant majority of our advertising revenue.

During the third quarter, 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 prepare for the November promotional season.

At the end of September, we had 405 warehouses nationwide with approximately 9 million square meters in total space, up over 50% from 12 months ago.

Non-GAAP marketing expense ratio was 5.3 -- 3.5% in Q3, higher than the 3% in the same quarter last year as we continued to increase our branding effort 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 profit increased 171% to a record high of RMB 1.5 billion in the third quarter.

Non-GAAP net income attributable to ordinary shareholders was RMB 2.2 billion, with an increase of 359% on a year-over-year basis.

And our GAAP net income attributable to ordinary shareholders was RMB 1 billion, 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 RMB 9 billion during the quarter, mainly due to 2 reasons: one is the RMB 5.2 billion inventory buildup for the November 11 promotion season, which is largely a timing issue; and two is the much-anticipated CapEx including RMB 4.4 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 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 third quarter, our cash position remained very strong.

As of September 30, 2017, cash and short-term investments, mainly in money market funds, totaled RMB 41.8 billion, up 71% from RMB 24.4 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 from JD Finance for both current and prior year periods.

This concludes my prepared remarks, and we can now move to the Q&A session.

(Operator Instructions) Our first question comes from the line of Eddie Leung from Merrill Lynch.

I have a question on the product mix.

You are selling [luxury] brand.

From November 11 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 rate.

So wondering how that could affect our margins going forward.

So I assume you're referring to some of the brand -- higher-level brands in general merchandise category.

They obviously have very healthy margins.

This is also 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 would not be very material in the near term.

Got it.

Forgive me, 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.

Our next question comes from the line of Alicia Yap from Citigroup.

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 seasons 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, net margins of 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 much bigger, the 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.

(foreign language)

So for the gross margin question, I think there are 3 reasons.

One is from our first-parties business.

The scale economies has been driving our procurement cost 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 third quarter would also contribute to the sequential increase in the gross margin.

So related to that, to come back to your question on fourth quarter, I think if you -- I wouldn't guide for any single quarter, but if you want to take a benchmark, I should probably benchmark to the second quarter when we had also a very major promotion to the fourth quarter rather than comparing to the third quarter.

But again, we are not providing any guidance to bottom line for any single quarter.

(foreign language)

Yes, 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.

(foreign language)

Yes, so if you look at 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.

Our next question comes from the line of Ronald Keung from Goldman Sachs.

I think on the 3P revenue, as Sidney mentioned it, 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 has seen a massive increase on a quarter-on-quarter basis to 160,000 merchants.

So if we think about apparel and other marketplace merchants by category, can you just give us 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 Toplife, just want to share -- hear your thoughts on the 3P business and by category.

(foreign language)

So let me quickly translate.

You may have read from the media that we are experiencing some headwinds, over 100 merchants in the general merchandise category has withdrew from -- withdrawn from our platform due to certain competition's practice in the market and leading to some of the merchants going to 1 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.

(foreign language)

So we have, throughout our history, experienced many of these competition where our competitor would force the merchants choose 1 out of 2 platforms, almost every 2 years to 3 years.

In the earliest days that our digital IT products, we faced this competition.

And then later with -- 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.

(foreign language)

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 which, in return, would also help us to grow with these brands.

So today, maybe in apparel segment, we are only 1/3 to 1/5 of our major competitor's size.

But over time, if you actually check with these brands, the brand's profitability on JD.com...

Net profitability.

Net profitability on JD's platform may not be actually any less than their profit on the larger platform.

(foreign language)

So throughout our history, every -- in any category -- in every category, we always encountered this competitive tactic and it's almost inevitable, but it's also -- it can always be overcome.

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.

(foreign language)

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 demonstrate really our platform has been offering the female customers great value proposition.

I just want to add one more point that Richard mentioned earlier is that even though our current quarter actually saw stagnant growth in apparel category and which could also last 2 quarters to 3 quarters, but we are confident that past -- beyond the next 2 quarters to 3 quarters, we will see growth resume again and -- just as we saw in other categories, reach inflection point.

(foreign language)

When we have more and more female consumers on our platform, the growth from the apparel segment will be almost inevitable.

Our next question comes from the line of Jerry Liu from UBS.

My question is relating to the cash flow statement.

So 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 improvement even excluding this benefit from the financing business.

Well, there's no impact from 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 focused trying to overcome some of the merchant withdrawing from our platform.

So we revert to the first 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.

So none of these are related to JD Finance.

In fact, we are supporting JD Finance, not the other way around.

(foreign language)

Yes, so on a full year basis, you can be assured that our free cash flow will always be positive from JD [more] alone.

In fact, if you look at the last 12 months, the free cash flow was still very, very strong.

Our next question comes from the line of Grace Chen from Morgan Stanley.

We can see that JD has been delivering very good margin improvements, but at the same time, we also see that you're accelerating investments as well.

I think Richard has mentioned that JD in general will reinvest the excess return.

So if [we see] the excess return and half that will be in technology, but as you can see, we have many other investments including we're investing FMCG, branding logistics, overseas expansion as well.

So what will be the priority of these other investments?

And also can you help us rank them when these various investments in terms of size?

(foreign language)

Yes, so most of the items you mentioned earlier are actually part of regular businesses, 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.

Our next question comes from the line of Jin Yoon from Mizuho Securities.

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, just going back to the CapEx, are we pretty much done with the CapEx spending for this calendar year or should we -- some of that, that land rights investments -- should that trickle into the fourth quarter as well?

So for the 100-plus merchants that left the platform, essentially, they actually -- they are ones closed 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 -- 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 fourth 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 that we can lease them back.

So they can be easily monetized.

And it's actually very scarce resources that only JD and very good economy companies can have the privilege to acquire them.

Our next question comes from the line of Natalie Wu from CICC.

Richard, you've just mentioned that as long as the net profit margins would be improved at similar level scale in every year, so you are happy to invest actual money into the R&D growth, et cetera.

So can it be interpreted as margin guidance, let's say, next year could be 1% higher than this year?

(foreign language)

Yes, 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.

Our next question comes from the line of Chi Tsang from HSBC.

I'm wondering if you can comment a little bit on your M&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?

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's 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 partner's local expertise and their local consumer insight.

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 great channel, distribution channel.

We are also developing our technologies to empower other partners.

So some of those potential investments could be also in technologies, so not only from in-house R&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.

Our next question comes from Alex Yao from JPMorgan.

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 a price 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.

Will there anything that you guys can do such as data exchange, product integration, et cetera, to drive more user growth from Tencent's social platforms?

And how should we think about the user growth trending in the next couple of quarters?

(foreign language)

Yes, so really, 2 customer segments we're seeing greatest growth: one is female customers, and two, is customers from the lower tier cities.

(foreign language)

Yes, 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.

(foreign language)

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 extend our partnership not only online, but also to off-line where we can create synergies between the 2 companies.

Our next question comes from the line of Shi Jialong, Nomura Securities.

(foreign language) I will translate the questions into English myself.

I have 2 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 apparel business to recover from 1Q next year.

So I just wonder what strategies management may have to turn around the apparel business.

(foreign language)

Yes, so first, our agreement with Tencent will not expire until 2019, so it's still quite early before we start discussions with Tencent.

(foreign language)

Yes, so we believe we'll have clearly priorities in getting new support.

And if we can reach agreement, that will be great.

If not, we'll also have great options.

(foreign language)

Yes, so maybe the type of collaboration could be different, but we are very certain that the 2 companies will cooperate closely together.

(foreign language)

Yes, so in terms of apparel, obviously, this is in the midst -- a midst of intense competition.

So for trade, for confidentiality reasons, we would rather not share anything further at this point.

(foreign language)

But if you look at our promises in the past 10-plus years, all of our promises would always realize in the end.

Our next question comes from the line of John Choi from Daiwa.

I have a question on your other -- services and other revenue.

Could you give us some more color, especially given that the third-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 -- could let us know the current status or the relationship Walmart given that it's been about a year since the Yihaodian deal.

So where have you guys achieved?

And how do you think this relationship will evolve into?

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 earnings release that we actually -- one of the recent initiative is to promote a joint membership between JD's JD Plus and Sam's Club membership.

So we definitely -- this is just 1 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.

(foreign language)

Yes, so we are exploring additional collaboration in our online, off-line effort.

(foreign language)

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 in 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.

(foreign language)

Yes, so we have in the most recent quarter 2.6 -- 266 million active customers and these are all very, very valuable middle class and upper middle class consumers.

So this definitely creates a great platform for the brands and the merchants.

Any smart merchant would clearly not walk away from our platform in a long -- over extended period.

Not only smarter merchants, but also stupid ones.

Our next question comes from the line of Wendy Huang, Macquarie.

I have 2 questions.

First, just to follow up on Richard's comment about female users and also penetration into the low tier cities, can you give us a breakdown of your 266 million customers by gender 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 has been a lot of players in the market start to revamp their B2B product to connect with hundreds of thousands of mom-and-pop shops in China.

For example, Alibaba has Lingshoutong.

[Investors] also doing similar stuff, [Sard] also launched a B2B sourcing platform.

And JD, I think, also has a product called [Xiangwei Bao].

So can you share with us about your thinking behind your B2B strategy and also what's in your view the JD's competitive advantage in the industry are.

(foreign language)

Yes, so let me answer the second question first.

We do have a new business unit called [Xintonglou], and the app is [Xiangwei Bao].

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 Singles' Day alone, opened 1,111 new stores in 1 single day.

(foreign language)

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.

(foreign language)

So we will help these brand partners to penetrate and reach those convenience stores as part of their channel expansion.

(foreign language)

Yes, the second advantage is our logistics network.

By the end of this year, we are already covering 100% of the provinces and counties and we can also serve even the rural areas.

(foreign language)

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.

(foreign language)

Yes, so without the existing logistics network, any third party, any other players who wanted to reach these stores in the rural areas, would 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.

Our next question comes from the line of Thomas Chong from Crédit Suisse.

I have a quick question about JD 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?

(foreign language)

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.

(foreign language)

Yes, so we'll have 3 ways to improve our logistics network.

First is through increased order numbers so that we can further enhance order density and efficiency.

(foreign language)

Yes, so second is that we will make a great effort to expand our business serving third-party merchants and partners.

So our objective is in 5 years, the external revenue will be above 50% of the total logistics revenue.

(foreign language)

So within the last 2 quarters, we already attracted over 100 major brands to our logistics platform.

(foreign language)

Yes, so in addition to the service level and great coverage, we'll also innovate constantly in our logistics capability.

One example is that we expanded our cold chain 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 in route to their home.

So you can see the temperature movement throughout the delivery process.

(foreign language)

Yes, we will also expand the same-city delivery services through our partner, New Dada.

(foreign language)

As we extend our partnership with Tencent to its off-line return network, we believe that in the future, maybe half of the products will be available in the same cities from the merchants and retailers and the same-city delivery network will be very critical to provide those services.

(foreign language)

Yes, so we have also launched the first ever on-land 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 have also had 170,000 testing hours for our joint 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 the leader in modern innovative logistics solution provider.

(foreign language)

So another fact that I wanted to mention is that our automated...

Self-driving trucks.

Self-driving trucks, we have tested that for 500 kilometers, we only need human intervention 2 times.

Less than 2 times.

Less than 2 times.

Our next question comes from the line of Alvin Jiang from Deutsche Bank.

We noticed that JD has announced a series of cooperations with other Internet companies in addition to Tencent like Baidu, like NetEase.

So my question is what's the underlying reason to do that and how are expectation on these corporations?

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 JD.com's Ruiyu Li for closing remarks.

Thank you for joining us today.

Please feel free to contact us if you have any further questions.

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.