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Ladies and gentlemen, good day, everyone, and welcome to the Vipshop Holdings Limited’s Second Quarter 2019 Earnings Conference Call. At this point, I would like to turn the call to Ms. Jessie Fan, Vipshop’s Director of Investor Relations. Please proceed.
Thank you, operator. Hello, everyone, and thank you for joining Vipshop’s second quarter 2019 earnings conference call.
Before we begin, I will read the safe harbor statement. During this conference call, we will make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that are based on our current expectations, assumptions, estimates and projections about Vipshop Holdings Limited and its industry. All statements, other than statements of historical facts we make during this call, are forward-looking statements. In some cases, these forward-looking statements can be identified by words or phrases such as anticipate, believe, continue, estimate, expect, intend, is or are likely to, may, plan, should, will, aim, potential or other similar expressions. These forward-looking statements speak only as of the date hereof and are subject to change at any time, and we have no obligation to update these forward-looking statements.
Joining us on today’s call are Eric Shen, our Co-Founder, Chairman and CEO; and Donghao Yang, our CFO.
At this time, I would like to turn the call over to Mr. Eric Shen.
Good morning and good evening, everyone. Welcome and thank you for joining our second quarter 2019 earnings conference call. We believe the strong operational and the financial results for the second quarter of 2019. During the quarter, our total active customers continue to grow at healthy pace, increasing by 11% year-over-year. Since we refocused on discount retail, the stickiness of both our existing and new customers have improved. We are pleased to see our existing customers becoming a lot more active, while at the same time new customer repeat purchase rate in the quarter after the first purchase has increased, the success as a result of our focus on merchandising.
Since we refocused on discount apparel and our profit, we have seen strong improvement in our financial results and key operating metrics, prove our strategy is very effective. We remain committed to executing on our merchandising strategy and further expanding our market share in the discount apparel sector in China. We are confident that we can continue to deliver steady profit improvement in the future, which will generate sustainable long-term shareholder return.
We strive to be the one-stop discount retail platform for our suppliers, serving all their inventory management issues in the offline segment within our ecosystem. We have over a decade of experience in online discount retail and we believe in this stage and time, online and offline are closely linked. Shoppers were increasing demand, omni-channel shopping experience giving that we begin to enter the offline discount retail segment this year. And our acquisition of Shan Shan Outlets is an important part of our new retail strategy. Shan Shan Outlets is a profitable business with a healthy operating cash flow. Importantly, they have a top-notch management team with a decade of experience in managing and the operating outlets in China, whom will stay with Vipshop after the acquisition.
Certainly, we will continue to focus on our online business, while our offline strategy including our investments into Shan Shan Outlets, Vipshop offline stores and Vipmaxx offline stores is complimentary to our offline – to our online business. Our goal is to help our suppliers manage their inventory cycles more effectively via different channel within our ecosystem.
At this point, let me hand over the call to our CFO, Donghao Yang so that he may discuss our strategy in more detail and go over our operational and financial results.
Thanks, Eric and hello, everyone. We finished the second quarter of 2019 with robust financial results. Our top line grew by about 10% year-over-year exceeding our expectations. Importantly, our non-GAAP net margin attributable to Vipshop’s shareholders increased by 1.9 percentage points year-over-year, which is the result of improved gross margin and more effective cost control.
During the quarter, we generated robust free cash flow of RMB1.2 billion, as compared with negative free cash flow of RMB903 million in the prior year period, representing a RMB2.2 billion increased year-over-year. In the second quarter of 2019, we saw improved conversion rate and elevated customer engagement from both our existing and new customers. As a result of that, our GMV grew by 11% year-over-year, driven by the robust growth in our core categories.
Specifically GMV from apparel-related categories has seen 19% year-over-year growth, which is the fastest among all major categories. During the quarter, we made further progress in outsourcing our last mile delivery to third-party couriers, currently around 30% of our daily orders are delivered by third-party partners. We continue to carefully monitor the effect on customer experience throughout this process and are evaluating whether or not it would be beneficial to outsource more orders, which will further reduce fulfillment cost.
We will be prudent in our investment in the offline segments as they are more asset heavy than the online business and we need some time to gain operating experience in this new area. Rest assured, we will be monitoring the profitability and return on investment from all our businesses very closely. The focus on the high margin apparel category has and will continue to enable us to deliver improvement in our gross margin and overall profitability.
Now moving on to our quarterly financial highlights. Before I get started, I would like to clarify that all financial numbers presented today are in renminbi amounts and all percentage changes refer to year-over-year changes unless otherwise noted.
Total net revenue for the second quarter of 2019 increased by 9.7% to RMB22.7 billion from RMB20.7 billion in the prior year period, primarily driven by the growth in the number of total active customers. Gross profit for the second quarter of 2019 increased by 25.9% to RMB5.1 billion from RMB4 billion in the prior year period. Gross margin increased to 22.4% from 19.5% in the prior year period.
Fulfillment expenses for the second quarter of 2019 were RMB2.2 billion as compared with RMB1.9 billion in the prior year period. As a percentage of total net revenue, fulfillment expenses were 9.7% as compared to 9.1% in the prior year period, primarily attributable to a write-down of RMB276 million related to the Zhaoqing warehouse due to land subsidence during construction. Excluding the write-down, fulfillment expenses as a percentage of total net revenue for the quarter were 8.5%.
Marketing expenses for the second quarter of 2019 decreased to RMB878 million from RMB900 million in the prior year period. As a percentage of total net revenue, marketing expenses decreased to 3.9% from 4.3% in the prior year period. Technology and content expenses for the second quarter of 2019 decreased to RMB422.3 million from RMB511 million in the prior year period. As a percentage of total net revenue, technology and content expenses decreased to 1.9% from 2.5% in the prior year period.
General and administrative expenses for the second quarter of 2019 were RMB706 million, as compared with RMB615 million in the prior year period. As a percentage of total net revenue, general and administrative expenses were 3.1%, as compared with 3% in the prior year period.
Our income from operations for the second quarter of 2019 increased by 141.2% to RMB965 million from RMB400 million in the prior year period. Operating margin increased to 4.2% from 1.9% in the prior year period.
Non-GAAP income from operations, which excludes share-based compensation expenses and amortization of intangible assets resulting from business acquisitions, increased by 97.6% to RMB1.2 billion from RMB595 million in the prior year period. Non-GAAP operating income margin increased to 5.2% from 2.9% in the prior year period.
Our net income attributable to Vipshop shareholders for the second quarter of 2019 increased by 19.3% to RMB814 million from RMB682 million in the prior year period. Net margin attributable to Vipshop shareholders increased to 3.6% from 3.3% in the prior year period. Net income attributable to Vipshop shareholders per diluted ADS increased to RMB1.21 from RMB 0.99 in the prior year period.
Non-GAAP net income attributable to Vipshop shareholders, which excludes share-based compensation expenses, amortization of intangible assets resulting from business acquisitions and equity method investments, tax effect of amortization of intangible assets resulting from business acquisitions, investment gain and revaluation of investments excluding dividends, tax effect of investment gain and revaluation of investments excluding dividends, and share of gain in investment of limited partnership that is accounted for as an equity method investee, increased by 84.2% to RMB1.1 billion from RMB577 million in the prior year period.
Non-GAAP net margin attributable to Vipshop shareholders increased to 4.7% from 2.8% in the prior year period. Non-GAAP net income attributable to Vipshop shareholders per diluted ADS increased to RMB1.58 from RMB0.84 in the prior year period. As of June 30, 2019, our company had cash and cash equivalents and restricted cash of RMB7.8 billion and short term investments of RMB238 million. For the second quarter of 2019, net cash from operating activities was RMB3.4 billion.
Looking at our business outlook, for the third quarter of 2019, we expect our total net revenue to be between RMB17.8 billion and RMB18.7 billion, representing a year-over-year growth rate of approximately 0% to 5%. These forecasts reflect our current and preliminary view on the market and operational conditions, which is subject to change.
With that, I would now like to open the call to Q&A.
Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from the line of Joyce Ju from Bank of America. Please ask your question.
Good evening, Shen, Donghao, Jessie. Congrats for the solid quarter. Thanks for taking my questions. I have two questions. The first question is actually is regarding our improvement in gross margin this quarter. May we have a general sense like how much of those growth margin improvement not actually from the category mix, i.e. like some highly profitable categories like taking a bigger percentage off total GMV and one part of them are actually coming from other reasons such as like we have less discount or promotions.
My second question is regarding the cash flow, because we now have generally quite rapid strong growth in terms of cash flow. Do we have any plans in terms of like CapEx for this year or next? And except from CapEx are we going to have any plan such as like share buyback or like dividend payout? Thank you.
Well, thank you very much for your question. Let me take your first question about, what caused the gross margin improvement in this quarter. Before we mentioned, the apparel is a bigger portion in the mix, I mean, that’s absolutely right. And we’re now focusing more on discount retail and more on apparel category, but specifically how much of the shift in mix has contributed to the gross margin improvement. I don’t have that number as of now. We can do this calculation for you after this.
[Foreign Language]
Okay. Well let me take your second question. Well, yes, we do have a very strong cash flow right now. But with that kind of cash flow, we don’t have any plans to increase our CapEx for the foreseeable future. And I think we’ve guide – we’ve told the market that for this year the total CapEx will be around RMB3 billion, including warehouse construction and the headquarters building. And as of today, as of now, we do not have any plans to buyback any share in the foreseeable future.
Your next question comes from the line of Natalie Wu from CICC. Please ask your question.
Hi management, thanks for taking my question. This is [indiscernible] for Natalie. First congratulation on the strong quarter. We would like to understand, like, firstly, what is your rationale behind the acquisition of Shan Shan Outlets. And when shall we expect to see synergy from this deal? Thank you.
[Foreign Language]
[Foreign Language]
So we have an expert in discount retail in China’s market and we have been doing this discount retail online for over 10 years, and we’ve been called to the online outlets by many others. So we actually think this acquisition is highly complementary, because the outlet of the offline business is growing quite fast in China and the market is currently underpenetrated. The growth rate is around 20%. And customers nowadays increasingly go both online and offline for their shopping needs. So we do think there will be a lot more synergy in the future.
Through this acquisition, we will be gaining more bargaining power from our supplier side. And then acquire in additional great channel to clear more inventory for our suppliers and venture into areas such as online-offline integration, smart retail and so on. In the future, we will be exploring different models for expanding the offline outlet business, including lighter asset models in which we help manage and operate the outlet but not necessarily becoming the asset owners of the newer outlets that we will open in the future.
[Operator Instructions] We have a follow-up question from the line of Joyce Ju from Bank of America. Please ask your question.
Yes. Hi Shen, Donghao, Jessie. Just have a follow-up question regarding the acquisition with Shan Shan. I just try to understand, after we consolidate the Shan Shan business, like how it will impact our financial numbers? And my second follow-up is just try to get a sense, because we see the – our outlook for third quarter of growth was seeming like decelerating from the second quarter. I’m just wondering if [indiscernible] outlook in terms of – into the second half. How the company looking at the growth rate or general, like, online retail segment, or like, apparel sectors growth in the second half. Do we foresee a quick slowing down or it’s just seasonality? Thank you.
[Foreign Language]
All right, well, thank you very much for the question. Let me take your first question. Regarding the impact on overall financials after the consolidation of Shan Shan business. Well, first of all, the impact in our top line is going to be limited because we will book the revenue from Shan Shan on net basis, meaning, the number is going to be relatively small compared to our total revenue. And in terms of bottom line, Shan Shan is a profitable business. So after consolidation, Shan Shan’s number will be accretive to our overall financial results. So there’s no need to worry about that.
[Foreign Language]
In the second half, e-commerce industry still looks to have very healthy growth. That’s what us since we’re mainly an apparel discount retailer, Q3 is traditionally a very light season due to seasonality for the apparel category. Therefore for us in the third quarter, we usually tend to be more conservative with the growth rate given that there are limited promotional events and the seasonality. However, for the second half, we continue to have confidence in customer growth, repeat purchase and other operating metrics going forward.
Your next question comes from the line of Alicia Yap from Citigroup. Please ask your question. Miss. Alicia Yap, your line is open. You can ask your question.
Hi. Sorry. Can you hear me okay?
Yes, we can hear you.
Please go ahead.
Yes, sorry about that. So good evening, Shen, Donghao and Jessie, thanks for taking my question. So I joined a call late, so I’m not too sure if this is being asked, apology in advance. Actually I have questions on the Shan Shan Outlets acquisition. Can management elaborate a little bit in terms of the near term and short term synergy you expect to realize through the expansion into the physical outlet store exposure? How will that bring synergies to VIP online market site, both in near term and short term – near term and long term?
Thank you. Alicia. [Foreign Language]
[Foreign Language]
So Alicia, we looked at the brands at Shan Shan carry and the brands that we sell and find that the brand is highly overlapped. And therefore there is a lot of synergy on the brand side, giving us more bargaining power and giving us more access to inventory. Additionally, we strive to create a better inventory solutions platform for our suppliers and that does mean we need various channels both online and offline to clear inventory more comprehensively for our suppliers. Additionally, this also offers more channels for us to acquire customers and explore online-and-offline integration.
Going forward, we will be looking at expansion plans for Shan Shan. In the long term, we do believe that there is a lot of growth potential in the outlet industry in China as the market is currently quite underpenetrated. However, we will be looking at more asset light models in which we do more management for the outlets and operating side of the outlets rather than owning and building the physical land and the assets – and the commercial assets.
Your next question comes from the line of Sally Chan from CLSA. Please ask your question.
Yes. Hi, good evening management. Thank you for taking my question. I have a question on the VAT reduction in China from 16% to 13%. How should we think about the benefit to our top line and margins in the second quarter? And have we factored in the benefit in our 3Q guidance or are we planning on passing on the benefits to our customers? Thank you.
Okay, well, thank you for the question. Let me take your question. Well, the 3 percentage point reduction on VAT tax rate, the impact of that our top line is close to 3% and the impact on our bottom line is roughly 0.5% to 0.6%, all positives. We already consider the impact of the new VAT – the impact of the new VAT tax rates, where we give the guidance to Q3.
[Operator Instructions] Your next question comes from the line of Melissa Chen from China Renaissance. Please ask your question.
Good evening, Shen, Donghao and Jessie. I have a question regarding of our outsourcing delivery to the third parties. I’m just wondering like how big impact should we expect on the financial statements and when should we expect the impact? Thanks.
[Foreign Language]
[Foreign Language]
Melissa, we started to outsource at least the portion of our orders starting in the second quarter to third-party delivery couriers. In the second quarter, around 12% of our orders were outsourced. So we are already seeing some benefits in terms of delivery savings in the second quarter. In third quarter, we continued to outsource more orders and around 30% of daily orders have been outsourced. We will continue to evaluate the shopping experience and the potential savings from outsourcing orders and continuing to evaluate whether or not it would be more beneficial to outsource more orders and save more while the customer experience should be undisturbed.
[Operator Instructions] You have a follow-up question from the line of Alicia Yap from Citigroup. Please ask your question.
Hi. Thanks for taking my follow-up questions. I wanted to ask on these ASPs per orders and also the orders number of growth. It does look like the ASP per order is trending down. And then whether this order number growth is reaccelerate a bit. So can we get some downward into this – what are some of the reasons that attribute to that? And then will we actually see the trend continue in the next quarter? Thank you.
[Foreign Language]
Thank you. Alicia.
[Foreign Language]
So Alicia, Ticket size declined year-over-year for several reasons. The first is that since we rolled out the Super VIP membership, the customers get free shipping and free return and therefore they will tend to order smaller sizes and order more frequently. That’s not the reason that ticket size has declined, but order frequency has increased substantially. The second reason is starting from the end of last year, we wrote out a note bundling policy. It seems that customers no longer have to buy multiple items in order to get free shipping to 288 in order to get some discount.
This policy means that they will tend to order what they like instead of buying additional items in order to get an incremental 10%, 15% of discount. It does affect the ticket size, but it also improves the shopping experience and reduces the return resulted from buying items just to get a discount. And lastly, our marketplace contribution has increased year-over-year from 4% in the second quarter of 2018 to 8% in the second quarter of 2019. Since orders in the marketplace tend to be smaller in order size and they’re shipped separately from our 1P orders, it did add a lot more orders as a result of the increase in marketplace contribution.
However, regardless of the ticket size decrease because the orders have grown very strongly, our ARPU remained healthy. This is a good sign. Now that means shoppers are shopping more frequently on our platform. So going forward we will continue to balance the ticket size and the shopping frequency. We don’t believe that ticket size should fall a lot more as these various factors are evened out on a year-over-year basis likely around a 4Q and next year.
Your next question comes from the line of Sean Zhang from 86Research. Please ask your question.
Hello, management. Thank you for taking my question and congratulations on the strong quarter. So my question is about supply. So according to the MDS data growth of the apparel sector has been very slow this year and the from what I see – financial reporting of the Asia companies, the branded apparel – a lot of branded apparel companies are also facing a lot of pressure, particularly in the inventory level. So I wanted to understand what’s the implication for VIPS, will that help you obtain better merchandise and grow your top line growth. Thank you.
[Foreign Language]
[Foreign Language]
We are also looking at the macro very closely because we’re mainly an apparel retailer focused on the discount apparel segment, we are actually seeing more inventories to be sold in the offline channel. Therefore we will continue to execute our merchandising strategy of bringing deep discounted products to our customers.
Your next question comes from the line of Thomas Chong from Jefferies. Please ask your question.
Hi, good evening. Thanks management for taking my questions. May I ask about our offline strategies over the next coming years? Should we expect, we invest our better than expected earnings into the offline segments, it all has to depend our integration between online and offline. Thank you.
[Foreign Language]
[Foreign Language]
So Thomas, we have two types of offline stores that we have opened in the past year. One type is called Vipshop, they are opened in the mall and we have opened slightly over 100 stores. And the other type is called Vipmaxx, it’s mostly opening the communities and have a lower positioning than the Vipshop offline stores. We have opened a few dozen of Vipmaxx stores as well. Both stores are focused on the apparel category and discounted retail in apparel. Currently we’re owning experimenting and exploring the offline segments. Therefore the revenue contribution to our overall business is still quite small. No matter if the business is online or offline, our goal is to have a profitable business. Therefore, in the future we will continue to look at the profitability of both our online and offline business, looking at the best way to both expand the business while also making the businesses very margin accretive.
Your next question comes from the line of Tian Hou from T.H. Capital. Please ask your question.
Yes, Shen and Donghao and Jessie. The question is, not sure it has been answered, if it has been answered I’ll move to the next one. Is that your acquisition of the Shan Shan comers and I want to know what’s the synergy between Vipshop’s online and Shan Shan? So that is one of the question. The second question, with all the bigger commerce vendors, BABA, JD, as well as Pinduoduo they all go to offline and lower tier cities. That’s their sort of a common approach. I wanted to – what’s the Vipshop’s approach going forward in terms of customer acquisition? Thank you. That’s two questions.
[Foreign Language]
So, on the Shan Shan acquisition, because we’re an expert in discount retail and having operating this business online for 10 years, we do see that there’s still a lot of opportunities offline. The offline business is growing quite fast at around 20%. And customers will increasingly go both online and offline to satisfy their shopping demand. Therefore, we do see a lot of synergy, especially on the supplier side where we will enlarge our bargaining power with a lot of our key suppliers because the brand overlap is quite big and we are working more channels to clear supply inventory more effectively for our suppliers.
[Foreign Language]
Tian, we are not particularly focused on a certain tier city in our marketing and our target audience. Our goal is to focus on apparel and particularly apparel in offline segment. Actually, if you look at our marketing target, we have clients even across the board, attracting customers who are receptive to the discounted branded apparel segments. In our numbers, Tier 4, Tier 5 customers contribute to around 30%. Therefore, it’s quite a substantial part of our business. We have tried in the past to expand more and do more marketing in the lower tier cities, but we have not found that to be a more effective than our investments elsewhere. Therefore, we will look at things across the board, we’ll continue to actively look merchandising strategy in offline segment.
Your next question comes from the line of Jamie Shen from Bank of China International. Please ask your question.
Hi. I just have a very quick follow up on the acquisition of Shan Shan Outlets. Along with the existing stores, I think there are still a few new ones to be opening in the future. And usually like for offline retail outlets it will take some time for the operation and profitability level to ramp up. So I just wonder whether there be any financial impact that we should be taking into account related to new store opening. Thank you.
Okay. Thanks for question. Let me take your question. Shan Shan’s management team is actually – we mentioned in our script, top-notch management in China’s outlet industry. They have a great track record in turning a new store into a profitable one within a very short period of time. So in the past to eight to nine years, they’ve opened five stores already. And on average it took them 18 months to turn a store profitable. So we’re very confident in the future, when they continue to open more stores and they will still be able to turn the new stores into profitable ones within relatively short period of time. And since they’ve already got five big stores that are already profitable, we believe that going forward, even with the plan to open more stores, the consolidation of Shan Shan’s financials to Vipshop will be a accretive in terms of bottom line.
[Operator Instructions] Your next question comes from the line of Hans Chung from KeyBanc Capital Markets. Please ask your question.
Thanks for taking my question and congratulations on strong results. So just a quick question regarding the gross margins. I know, the pretty good gross margin this quarter might be driven by the higher growth in apparel and also perhaps the VAT refund may contributes a little bit. Just going forward, how should we think about the gross margin in second half and next year? Is the gross margin in the second quarter could be a new base and then how many upside from here going forward. Thank you.
Thank you for your question. Well, the biggest reason why in Q2 our gross margin went up so substantially compared to last year or this Q1 – this past Q1 was, our refocus on discount retail in apparel. The impact of the new lower VAT tax rate on our gross margins roughly 0.5%, 0.6%, so compared to the shift on apparel that is relatively small. So that’s why, we are confident that if we continue to execute our new strategy of focusing on discount retail and apparel, we will be able to continue to deliver a steady improvement on our gross margin.
You have a follow-up question from the line of Tian Hou from T.H. Capital. Please ask your question.
[Foreign Language] The follow-up question is, I do realize Tencent and JD, you have some options to buy up more Vipshop’s shares. I wonder what’s going to happen in that front. And also for Shan Shan, if they continue to open more outlets, is that going to cause Vipshop’s more CapEx? So that’s the two questions. Thank you.
[Foreign Language]
[Foreign Language]
So Tian, Tencent has interest to buy up to 12% and JD 8%, and if they do buy incremental shares, we will be issuing public announcements via our filings.
[Foreign Language]
So Tian, for the five outlets in the pipeline for Shan Shan, the CapEx need is not too big as the land has already been secured for additional projects. In the future, we will be exploring more asset light model in which we don’t necessarily have to go out there and buy land and build out each outlet, but rather we would be engaged with the outlets in terms of managing and operating the outlets.
There are no further questions at this time. I would like to hand the conference back to the presenters, please continue.
Thank you for taking the time to join us and we look forward to speaking with you next quarter. Thank you very much.
Thank you.
Thank you.
Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may now disconnect.