Vipshop Holdings Ltd

NYSE:VIPS

Earnings Call Transcript 2018-Q3

[Operator]

Ladies and gentlemen, good day, everyone, and welcome to Vipshop Holdings Limited's Third Quarter 2018 Earnings Conference Call.

At this point, I would like to turn the call to Ms. Jessie Fan, Vipshop's Senior Manager of Investor Relations. Please proceed.

[Jessie Fan, executive]

Thank you, operator. Hello, everyone, and thank you for joining Vipshop's Third Quarter 2018 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 in its industry. All statements, other than statements of historical facts we may 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 Cofounder, Chairman and CEO; and Donghao Yang, our CFO. At this time, I would like to turn the call over to Mr. Eric Shen.

[Eric Shen, executive]

Good morning, and good evening, everyone. Welcome, and thank you for joining our third quarter 2018 earnings conference call. During the quarter, our total active customers grew by 11% year-over-year, showing continued improvement in our customer acquisition efficiency as well as synergies from the Tencent and the JD partnership business. New customers from Tencent and JD accounted for around 22% of our total new customers in the third quarter. Our ARPU also increased year-over-year, which was a result of our strong execution, especially in our CRM program as of the end of September, around 2.3 million customers joined our Super VIP paid membership program, which was a 21% increase quarter-over-quarter.

We continue to work with Tencent Video to unlock the value of the joint membership delivering more benefits to our paid members. Currently, we are making some adjustment in our product offering, reducing our investment into low margin, more standardized categories.

Our core competence lies in our ability to serve our female customers in fashion-related categories. These adjustments will allow us to focus on what Vipshop does best, which will be beneficial for our long-term growth and margin trend.

Looking ahead, we will continue to focus on our merchandising strategy, which will drive our future success. We aim to further deepen our expertise in this discount retailing, which will generate sustainable value for our customers, suppliers and shareholders over a long term.

At this point, let me hand over the call to our CFO, Donghao Yang, so that he may discuss our strategies in more detail and go over our operational and the financial result.

[Donghao Yang, executive]

Thanks, Eric, and hello, everyone. In the third quarter of 2018, our average revenue per customer increased by 5% year-over-year, driven by the strong improvement in the number of average orders per customer.

Our core strength lies in our ability to procure desirable products and offer them to our customers at very favorable prices, particularly in the apparel category. Therefore, we will continue to execute on our merchandising strategy further fortifying our leading position in this unique space.

On the logistics front, we continue to expand our warehousing capacity, adding another 40,000 square meters of warehouses in the third quarter. As of September 30, 2018, we have approximately 2.9 million square meters of total warehousing space, of which around 1.8 million square meters is owned by the company.

Turning to our Internet finance business. Approximately 5.4 million active customers used our consumer financing service during the quarter, which accounted for around 24% of GMV.

As of September 30, 2018, the total balance of credit outstanding to customers was approximately RMB 4.2 billion and the total balance of credit outstanding to suppliers was approximately RMB 1.3 billion.

We continue to look for external sources of funding to support the cash needs of our Internet finance business. In September, our Internet finance subsidiary completed its first offering of asset-backed notes in an aggregate amount of RMB 520 million.

Now moving on to our quarterly financial highlights. Before I get started, I would like to clarify that all the 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 third quarter of 2018 increased by 16.4% to CNY 17.8 billion, primarily driven by the growth in the number of total active customers and the improvement in average revenue per customer. Gross profit for the third quarter of 2018 increased by 3.8% to CNY 3.6 billion from CNY 3.5 billion in the prior year period. Gross margin was 20.4% as compared with 22.9% in the prior year period, primarily attributable to our investment into promotional activities.

Fulfillment expenses for the third quarter of 2018 were CNY 1.8 billion as compared with CNY 1.7 billion in the prior year period, primarily reflecting an increase in sales volume and number of orders fulfilled. As a percentage of total net revenue, fulfillment expenses decreased to 9.9% from 10.9% in the prior year period.

Marketing expenses for the third quarter of 2018 were CNY 578 million as compared with CNY 478 million in the prior year period. As a percentage of total net revenue, market expenses were 3.2% as compared with 3.1% in the prior year period.

Technology and content expenses for the third quarter of 2018 were CNY 491 million as compared with CNY 455 million in the prior year period. As a percentage of total net revenues, technology and content expenses decreased to 2.8% from 3% in the prior year period.

General and administrative expenses in the third quarter of 2018 were CNY 625 million as compared with CNY 547 million in the prior year period. As a percentage of total net revenue, general and administrative expenses decreased to 3.5% from 3.6% in the prior year period.

Our income from operations for the third quarter of 2018 was CNY 355 million as compared with CNY 448 million in the prior year period.

Operating margin was 2% as compared with 2.9% 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, was CNY 547 million as compared with CNY 703 million in the prior year period. Non-GAAP operating income margin was 3.1% as compared with 4.6% in the prior year period.

Our net income attributable to Vipshop shareholders for the third quarter of 2018 was CNY 229 million as compared with CNY 338 million in the prior year period. Net margin attributable to Vipshop shareholders was 1.3% as compared with 2.2% in the prior year period. Net income attributable to Vipshop shareholders per diluted ADS was RMB 0.34 as compared with RMB 0.56 in the prior year period.

Non-GAAP net income attributable to Vipshop shareholders, which excludes share-based compensation expenses; impairment loss of investments; amortization of intangible assets resulting from business acquisitions and equity method investments; tax effect of amortization of intangible assets resulting from business acquisitions; gain on disposal, revaluation and value changes of investments; and share of results in investment of limited partnership that is accounted for as an equity method investee, was CNY 501 million as compared with CNY 560 million in the prior year period.

Non-GAAP net margin attributable to Vipshop shareholders was 2.8% as compared with 3.7% in the prior year period. Non-GAAP net income attributable to Vipshop shareholders per diluted ADS was RMB 0.75 as compared with RMB 0.91 in the prior year period.

As of September 30, 2018, our company has cash and cash equivalents and restricted cash of CNY 6.5 billion and short-term investments of CNY 1.9 billion. For the third quarter of 2018, net cash from operating activities was CNY 221 million.

Looking at our business outlook for the fourth quarter of 2018, we expect our total net revenues between CNY 26.1 billion and CNY 27.3 billion, representing a year-over-year growth rate of approximately 8% to 13%.

With that, I would now like to open the call to Q&A.

[Operator]

[Operator Instructions] Your first question comes from the line of Binnie Wong from HSBC.

[Wai Yan Wong, analyst]

So I have a few questions here. One is on the merchandising strategy. In your opening remarks, I think Shen-zon and Yang-zong emphasized on the continuing execution and remain focused on the merchandising strategy. So can you give us a little bit more color as to -- in terms of, say, by product categories or international brands, contribution and along that line, so we can think -- have more color in terms of how we should see how the merchandising strategy can help us to drive further growth down the road would be very helpful? And second question is that if we look at the revenue growth, right, it seems to be a little bit soft, right -- on the soft side. Despite already factoring in some of the macro headwind and from company standpoint, do we starting to feel any impact on the consumption, on spending on more customers? How should we think about that? And also in terms of any outlook color you can share would be helpful? And then very lastly is on the operating margin. It seems to be stabilizing, right, this quarter. But in the fourth quarter, given it's a seasonally -- of course, we have a lot more discounts and promotions in the fourth quarter, usually seasonally the strongest. How should we expect on the margin would be helpful?

[Jessie Fan, executive]

[Foreign Language]

[Eric Shen, executive]

[Foreign Language]

[Jessie Fan, executive]

So Binnie, regarding your first question regarding merchandising strategy, Vipshop is focused on select merchandising for our customers. And good merchandising, good products will bring both new customers and be very effective in reaching existing customers, right? So we do believe that good brands at a good price that is what's our forthcoming [this week] and our DNA has already been in apparel and apparel is also a very profitable category. So going forward, we will continue to focus on our fortunes in the apparel category to grow our business.

[Foreign Language]

[Eric Shen, executive]

[Foreign Language]

[Jessie Fan, executive]

So Binnie, regarding your question on macro, we do note that the macro environment is not as positive and the growth is not as strong as last year or the first half of this year. So we are not too optimistic at the moment. Although we -- it's hard to tell at the moment. So not too much to share there. But we do believe that because we're focused on the discount retail segment, in terms of a macro slowdown, we are quite countercyclical.

[Donghao Yang, executive]

Okay. And then Binnie, I'm going to get back to you quickly on your third question on the operating margin. While you're right, in Q4, generally we're going to run more promotional campaigns compared to Q3. But again, in Q4, our top line is going to be much higher than Q3, meaning we're going to have more operating leverage in our operating expenses as a percentage of revenue. And also, as Eric just said in his opening remarks, we're making some adjustments in our product offerings, reducing our investment into lower-margin, more standardized categories and instead focus more on our core fashion-related categories, which typically have much higher gross margin. So with that kind of shift in our merchandising or product strategies, we believe that there will be improvement on our gross margin. So taking those into considerations, we believe that in Q4, in the foreseeable future, our net margin -- our op margin will remain stable.

[Operator]

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

[Vicky Wei, analyst]

This is Vicky Wei on behalf of Alicia Yap here. I have questions about guidance for 4Q. How should we interpret and reconcile the GMV growth for single day of 27% to your guidance of 8% to 13%? And also, I want to know, are there anything Vipshop can do to improve the traffic and conversion from JD and Tencent channel?

[Donghao Yang, executive]

All right. Thanks for your question. Let me answer your first part of your question. So GMV is not the same as our net revenue. So for example, the sales that we get from our marketplace are included in the GMV numbers, but only the commission that we charge, like 8% to 10% of the sales from the marketplace will be accounted for in our net revenue. So those are 2 different numbers. We did have a pretty good 11/11 campaign, but again, it's only just one of the promotional activities that we run in Q4. So it's not representative of the performance of the entire quarter. So Eric?

[Jessie Fan, executive]

[Foreign Language]

[Eric Shen, executive]

[Foreign Language]

[Jessie Fan, executive]

So Vickie, regarding your second question on Tencent and JD, the traffic and conversion, we do see solid customer acquisition and contribution from Tencent and JD channel. In the fourth quarter and onwards, we do believe that we'll continue to see a continuous contribution of new customer coming from WeChat and coming from JD. We are working with Tencent, especially the WeChat team to improve the conversion rate of the traffic coming into the wallet in each program, plus with customer matching, [indiscernible] out with these customers would like to buy. We are slashing stores and on [ our ] mini program. So we are seeing continuous improvement on the conversion rate month-to-month and we will continue to work on that.

[Operator]

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

[Ronald Keung, analyst]

I guess, my question also focuses on the growth and profitability. I'm just thinking, you're talking about we will cut back on some standardized items, standardized like FMCG or so. So even though the fourth quarter revenue guidance seems to be quite slow, I guess, GMV will be slightly higher, but it still shows quite a slowdown. If we think about a apples-to-apples only for off-season apparel versus the same period last year, how would you see the growth rate? Because if apparel is growing faster, it's actually some of your standardized low-profit categories that you announced doing less. Can you share some of the sort of like-for-like off-season and then in-season and how the growth rates of those -- should we expect those to be actually still growing more healthily versus the overall group growth that has slowed, according to your guidance?

[Donghao Yang, executive]

So thanks for your question. Again, we only provide guidance for the overall revenue growth for the next quarter. And we don't -- at this point of time, we're not in a position to provide a breakdown of the growth rates of different categories. I'm sorry about that. But again, as we said earlier, our focus will continue to be on our core categories, such as apparel, fashion, female customers and all that.

[Operator]

Your next question comes from the line of Alex Yao from JPMorgan.

[Alex Yao, analyst]

[Foreign Language] So Eric, can you share with us your high-level thoughts of the company's growth strategy for 2019? If you are only able to do one thing, what would that one thing be?

[Eric Shen, executive]

[Foreign Language]

[Jessie Fan, executive]

Alex, our focus is back on discount retailing and the deep discount product. And so what our customers are looking for when they come to Vipshop, and the category that was strongest [indiscernible] is seen with the apparel as we said in earlier remark. So looking at 2019, we would be looking at the steady and healthy and profitability would be our first priority. In the third quarter and fourth quarter of 2018, we've already cut back on some unhealthy promotions, some unhealthy lower margins cum [indiscernible] money. And the good news is we saw quite minimal impact on the overall business. So we do think this is the right direction to go. And in 2019, we will continue to go down this path and aim to build a healthy and stable.

[Operator]

Your next question comes from the line of Eddie Leung from Merrill Lynch.

[Eddie Leung, analyst]

My question is actually on your new users. Still your growing to a quite good extent. So just wondering if you could give us some color on the differences of the new uses that you see in terms of demographics and geographic location from, let's say, your JD channel versus Tencent channel versus the new users you obtained from other channels? That will be helpful.

[Jessie Fan, executive]

[Foreign Language]

[Eric Shen, executive]

[Foreign Language]

[Jessie Fan, executive]

So Eddie, in the first quarter, we disclosed that around 22% of new customers came from Tencent and JD channel. And looking at the age list, around 50% of new customers are Post '90s. So that means they're born after the year of 1990. And in terms of tier subsidy split, it's very similar to our existing customers and the growth is across the board. Looking at our new customers shopping behavior, the retention in spending in the initial -- in the beginning of them joining the platform is slightly lower then Post '80s and Post '70s customers. But over time, we do notice that they're growing much faster than those of the spending habits of the Post '70s and Post '80s, and they're very much catching up to the spending habits of the older customers.

[Operator]

Your next question comes from the line of Wendy Huang from Macquarie.

[Ellie Jiang, analyst]

This is Ellie on behalf of Wendy. I just have a quick question about the -- still the partnership with JD and Tencent. We already saw a very good progress with Tencent, especially with the new users coming from the Tencent wallet access, also on the mini-program. Could you give us some updates on the JD partnership? And also, any strategies going forward with them, especially with December promotions coming up, too? Also, I have another question about long-term margin outlook. We mentioned that we are coming back to the merchandise strategy and focusing on the discount retail, which is our core. Could you give us some color on the long-term profitability going forward?

[Jessie Fan, executive]

[Foreign Language]

[Eric Shen, executive]

[Foreign Language]

[Jessie Fan, executive]

Ellie, on the question on Tencent and JD collaboration. On Tencent, we have a wallet entry. And on JD, the way we collaborate with them, they opened a flagship store, which has a number of brands and our merchandising assortments. So JD's new customers purchased through the flagship store are included in our customer numbers. And in December -- the December eighth anniversary sale, it's our anniversary sale, which is quite a big promotion for us on an annualized basis. We'll also be running promotions on the JD flagship store. But in terms of the resources, it would not be the same importance and significance as [indiscernible].

[Operator]

Your next question comes from the line of Jialong Shi from Nomura.

[Jialong Shi, analyst]

[Foreign Language] So my question is about the competition landscape. And I just wonder how management think of the new entrants coming into the off-season apparel market such as [indiscernible], many of these new entrants are doing their business on WeChat platform. How does management think of these new competitors?

[Eric Shen, executive]

[Foreign Language]

[Jessie Fan, executive]

So Jialong, [indiscernible] are more 2 businesses. So we did launch something similar called, Wei Pincang, targeting WeChat merchants and our businesses. Our biggest business and biggest volume is in the 2C market. So we're not too worried about competition with the smaller 2B platform and we also did launch a separate app, Wei Pincang, to compete for those smaller businesses and serve them and their customers. At the end of the day, we believe the core competency of many of these types of models lies in the brand partners that you have and your pricing advantage. So we are quite confident in those regards.

[Operator]

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

[Yuan Liu, analyst]

Yes, I just want to talk about what the margin profile will look like or for Vipshop, as we focus more on quality goods and discounted goods and less on in-season goods? So could we see the first, on the gross margin side, margins may be returning to 20 or low-20 level sustainably? And then on a net margin -- let's say, on a net margin side, could we see an improvement from the -- around the 2.8% level we saw in the last 3 quarters? On one hand, the off-season fee-for-discount goods, as discussed earlier, have better margins. And, on the other hand, competition remains intense. So I just wanted to see what's the long-term view on margins from management?

[Donghao Yang, executive]

Thanks for your question. Again, as we said in our earlier remarks, in the future, we will focus more on our core categories, fashion-related categories, which typically have higher margins. And at the same time, cut back on our sales on those low-margin product offerings. And we believe by doing that, in the long term, we will be able to improve on our gross margin and overall profitability.

[Operator]

Our next question comes from the line of Monica Chen from Crédit Suisse.

[Monica Chen, analyst]

I just have a couple of questions around our Internet finance business. As we see quite strong growth of the number of users using the Internet finance services and also the flow imbalance of the customer loan. So firstly, I want to understand, like what is the current Internet finance business contribution to the other revenue as we see there's 95% in the other revenue this quarter? And secondly, we want to know like what kind of -- what level of interest rate you are currently charging for the service? And thirdly, how should we think about the long-term profitability level for the Internet business and the strategic synergies with our core discount apparel business?

[Donghao Yang, executive]

Okay. Thanks for your question. Let me answer your question one by one. First one, about 19% of the total other revenue actually has come from the revenue from our Internet finance business. Your second question, now we're charging, on average, 15% annual interest rate on the financing that we offered to our consumers. Going on forward, we believe that our Internet financing business will not only help us or support our core via eCommerce business, they help our customers by more and then help our core e-commerce business grow stronger, but also our Internet finance business itself can be a profitable business. If we can charge sustainable, long-term 15% average interest rate on our financing products and typically, our default rate is very, very low. And currently, it is below 1%. If you combine those 2 things together, 15% interest rate and less than 1% default, it's going to be a really profitable business. Again, we will always keep in mind the risks involved in those financing businesses.

[Operator]

[Operator Instructions] There are no further questions at this time. I would like to hand the conference back to today's presenters. Please continue.

[Donghao Yang, executive]

Well, thank you all for coming to our quarterly earnings conference call, and we look forward to seeing you next quarter. Thank you very much.

[Operator]

Ladies and gentlemen, that does conclude the conference for today. Thank you for participating. You may all disconnect.