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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Hello, and thank you for standing by for JD.com's First Quarter 2018 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, Ruiyu Li. Thank you.
Thank you, operator, and welcome to our First Quarter 2018 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 first quarter 2018. Following the prepared remarks, Mr. Liu and Mr. Huang will answer your questions.
Before we continue, I refer you to our safe harbor statements in earnings release, which apply to this call as we will make forward-looking statements.
Also, this call includes discussions for 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 -- unless otherwise stated, all the figures mentioned during this 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, strong core e-commerce profitability and improving overall net margin.
During the first quarter 2018, our net revenues grew 33.1%, ahead of our expectations. In particular, growth from net services revenues accelerated to 60% year-over-year, the highest growth rate in the past 8 quarters driven by advertising and supply chain management services.
Non-GAAP gross margin in the first quarter was 13.9% compared to 14.1% in the same quarter last year. If we look at JD Mall, excluding new businesses, non-GAAP gross margin improved 40 basis points from the same quarter in 2017, demonstrating a very healthy margin trend for our core e-commerce business.
I should point out that the gross margins I discuss here are for our own margin trend analysis only. As we previously mentioned, our business model is a combination of first-party online retail and a platform service business. Since the 2 business models have shared a common infrastructure, our cost and expense classifications are now comparable to many industry peers that focus only on one or the other. Therefore, our gross margins are less relevant for industry comparison purposes. During the first quarter, we continued to invest heavily in logistics and R&D. We further added 29 warehouses during the quarter to a total of 515 nationwide with 10.9 million square meters in total space by the end of Q1. The continued capacity expansion has affected gross margin for the logistics business and our expense ratio for the e-commerce business, especially in a seasonally slow quarter. The fulfillment expense ratio increased 32 basis points from the same quarter last year. The good news is over 20,000 merchants are now using our supply chain services, including over 60% of our top 200 merchants. The revenues from the third-party logistics services have been growing in triple digit in the past 2 quarters and the number of third-party orders fulfilled by JD Logistics through our warehouse network has increased to approximately 20% of the total 3P physical orders, which, in turn, improved the customer experience on our platform. Our R&D expenses totaled RMB 2.4 billion or 2.4% of our net revenues during the quarter, up 70 basis points from the same quarter last year. We believe investments in technologies and R&D talent are critical to this continued innovation required for further improving our retail customer experience and empowering our business clients through our retail infrastructure service offerings.
The increase in merchants using our logistics network is a good example of how we are looking to commercialize our infrastructure as part of our Retail as a Service strategy. Our R&D investments in other areas such as AI-driven advertising and data analytics are also gaining momentum in revenue generation as business clients benefit from the technology and scale that we have built out.
Another example is our recently developed WeChat store, Mini-Program, which has been adopted by thousands of our brand partners since its official launch a little over a month ago at the end of March. It's a turnkey solution that enables the brands to open a WeChat store with all the essential store functions plus embedded JD infrastructure offerings such as logistics, advertising and JD membership benefits. Brands can manage their own fence while still enjoying all the perks and tools from the JD platform.
As a result of our spending in logistics and R&D, non-GAAP operating margin was 0.8% in the first quarter. Excluding new businesses, the non-GAAP operating margin for JD Mall was 2.1%, comparable to the same quarter last year, supported by higher gross margin and the lower marketing expense ratio offset by the higher R&D spending.
Our free cash flow was negative RMB 8.8 billion during the quarter, which was largely due to a RMB 5.3 billion decrease in advance from customers and payable to merchants related to a complex settlement process change we've been going through to settle the marketplace transactions directly through third-party payment companies as required by the regulators. The accumulated impact of this settlement process change from the second half of last year to the first half of 2018 will be over RMB 9 billion in total.
Excluding the onetime effect, our operating cash flow would have been positive in the first quarter 2018. The remaining impact is mainly from the timing of supplier payment as accounts payable decreased as of March 31, 2018, from the prior year-end. Our GAAP net income attributable to ordinary shareholders totaled RMB 1.5 billion in Q1 2018, which set a new record. The net income benefited from the fair value gains on investments during the first quarter in accordance with the new financial instruments accounting standard that took effect on January 1, 2018. In addition, we also recorded an accumulated RMB 1.2 billion gain on investments as of December 31, 2017, in the retained earnings upon this new adoption. As the mark-to-market changes of these investments may not correlate to our core operational performance on a quarterly basis, we have excluded the fair value change in the non-GAAP earnings calculation.
Our non-GAAP net income in the first quarter 2018 was RMB 1 billion with a 1% net margin. While this margin is below the prior year level, it was generally in line with our internal Q1 operational plan as our financial budget was established on an annual basis according to each year's unique operational priorities, which may not track the prior year's quarterly pattern. Our commitment to the full year earnings remains unchanged.
This leads us to our financial outlook. We expect Q2 2018 net revenue growth to be between 29% and 33% on a year-over-year basis. We would also like to reiterate our non-GAAP net margin for full year 2018 to be between 1% and 2%.
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.
We understand that you guys have been investing in JD Logistics not only to support your scale, but also to serve third-party merchants. I'm just curious that if we look at the increase in capacity of your logistic network, broadly speaking, you're -- not the detail, but just broadly speaking, how much you guys are kind of like preparing for your own business expansion? How much you guys are preparing for potentially kind of like a third-party logistic demand?
[Foreign Language]
Yes. So we expect in 5 years the third-party logistics service volume would be more than our internal first-party fulfillment volume. And the current capacity expansion is shared by both first-party and third-party logistic needs. So we don't separate them at this point. But as I mentioned on the last earnings call that we have built out quite a bit of capacity in the second half of last year, so it would take a few quarters to digest those capacities. And Q1 was a seasonally slow quarter, so that's why the impact would still last. But we have seen that for our third-party logistics services, the margin has improved on a monthly basis in the first quarter this year.
[Foreign Language]
And we are also looking to establish a logistic real estate fund that -- where we can leverage third-party capital to fund our logistics infrastructure, which I briefly mentioned in the past and we hope to materialize in the later part of this year.
Our next question comes from the line of Alicia Yap from Thomson Asia.
Sorry. This is Alicia from Citi. My questions is related to the logistic investment cycle. So how long should we expect the step-up investment to last? I understand that it actually started like fourth quarter last year, so we already see some impact in this first quarter. And how should we be thinking about the investment? Will 4Q this year we start to see some normalized trend? And then on the longer term, what could be the optimal margin profile for your third-party logistic business? And if you also have any revenue target for the third-party logistic business revenue this year?
Well, Richard just mentioned the third-party logistic revenue will exceed 50% in 5 years.
[Foreign Language]
Right. So we had anticipated a Q4 increase in volume for our third-party logistics services because we just announced the new initiative in the second half. So that's why we had, as I also explained earlier, we had a fairly large volume of new -- or large space of new warehouse became available in Q4 last year. And Richard was saying that after a few quarters that we digested those warehouse space going forward, we'll manage the expansion on a more timely and really just-in-time basis so that there won't be any major overcapacity situation like we experienced in the past couple of quarters.
Our next question comes from the line of Ronald Keung from Goldman Sachs.
While GMV is not a key metric, I see revenue growth very strong particularly for services. Just want to ask on the GMV sort of mix if -- how is apparel growth in the first quarter? And if we exclude apparel, is it comfortable to say that the overall category growth altogether was still faster than industry? I think, Richard, you mentioned overall definitely our aim is to grow faster than the industry, and given that the overall online goods growth was 35%, I was just thinking how each of these categories are growing? And if we exclude apparel, are we still on track to grow -- growing faster than the industry?
Yes. So good question. We had actually mentioned that for the apparel category, because of the competitive situation, we had experienced some merchant departure. Now we have seen some of them coming back in the first quarter, but the overall apparel category will take a few quarters to recover, as we mentioned last -- late last year. So in Q1, apparel category continues to be very weak. Our overall category is not growing and some of the female apparel category, for example, is even declining slightly. But excluding the apparel category, overall, all of our other categories are growing at a very healthy rate and we believe is growing at industry -- above-industry level.
[Foreign Language]
So Richard mentioned that if he remembers correctly, in Q1 last year, our apparel business was growing at over 90%. So clearly, the impact from certain anticompetitive measures from our competitor has clearly created some short-term impact on our business. And -- but we believe and we would like to reiterate that the management is very confident that the impact will not be long term. We have experienced similar practices in the past in other categories, and we are fully confident that we will regain this category back down the road.
[Foreign Language]
So other than apparel, all of our other categories are growing at a very healthy rate. For example, for mobile phone category, the industry was -- saw a negative 26% negative growth in Q1, but our category for mobile devices has seen very, very healthy growth rate. So really other than apparel, and to a lesser extent some home products, all of our other categories are very healthy. I just wanted to add apparel is a very profitable category, as you know, but without the apparel category, our core e-commerce JD Mall business continued to deliver a very healthy profit margin, which is also a validation of the strong resilience of our business model.
Our next question comes from the line of Jerry Liu from UBS.
I want to talk about JD Mall margins. When we look at this quarter versus a year ago, what are some of the drivers for the margin to be just a little bit lower? And if we look at the full year, do we still expect JD Mall margins to improve this year versus last year?
Sure. As I mentioned earlier, the JD Mall gross margin improved 40 basis points from the same quarter last year. So this is still the margin -- gross margin is driving the profitability. And gross margin came from 2 areas, one is the first-party product gross margin, which continued to expand because of our scale economies; and then two is the advertising revenue growth also adding overall profitability. And -- but the margin gain has been offset by our investments in R&D and technologies. So all in all, the operating margin remained relatively stable comparing to last year. And on a full year basis, we are very confident that JD Mall margin will improve again this year.
Our next question comes from the line of Jin Yoon from Mizuho.
Sidney, by keeping full year net income margins intact, does that mean net income seasonality may be upside down this year where 1Q and 3Q could be weaker than expected and 2Q and 4Q could be better than expected? In other words, if we felt significant capacity build in the last several quarters, with lower volumes in 1Q and 3Q we see stresses in margins due to overcapacity, but couldn't that reverse in 2Q and 4Q as volumes ramp up eating into that capacity? How should we look at that discrepancy?
Yes. I think for the logistics business, your assessment could be very much true that in Q2 and Q4, given the higher volume, our capacity utilization should improve. But there will be also other dynamics, for example, promotions in Q2 and Q4. But as I mentioned earlier, we plan our business operational plan for the entire year. We don't necessarily track prior year's quarterly pattern. We do have our commitment for the full year performance. So this year, you're right, the logistics -- the external logistic business could perform in somewhat of a different quarterly pattern than the last year.
Our next question comes from the line of Natalie Wu from CICC.
Just want to get a sense about the currency and the split between your 1P and 3P business. And also for the second quarter guidance of 29% to 33% year-over-year growth, what does it imply if we separate out the 1P sales versus services and others business? Should we expect their growth separately?
If we exclude apparel category, actually the other -- the remaining categories, whether it's 1P or 3P basis, they're all growing at very healthy rate and growth ratio would be quite comparable. But if you -- including the apparel, our first-party business in Q1 obviously are growing faster than the 3P business.
Our next question comes from the line of Thomas Chong from Crédit Suisse.
I have 2 questions. The first question is about the synergies with Vipshop. Can management comment about how the trend is so far? And my second question is about 7Fresh. Can management comment about the latest developments so far? And what's the goal for this year?
[Foreign Language]
Yes. For Vipshop, we just completed the system integration. The store has been up and running and we are pleased to see the weekly sequential growth has been very healthy week after week. However, it will require more time, first, to accumulate the fans and the customer momentum for the VIP offering. But the current progress has been very -- we're very pleased with the current progress.
[Foreign Language]
Yes. So the overall collaboration is within our planned schedule.
[Foreign Language]
Yes. So for 7Fresh, right now we have 2 stores. The sales per square meter has been doubling the traditional off-line stores. And we're planning to open another 2 in May and 3 in June. So in the second half, there will be more rolling out to a total of over 20 stores by the end of this year.
[Foreign Language]
Yes. So once we prove the store model, we can roll out in our 7 regions across the country through our own operations or through franchise model.
[Foreign Language]
Yes. We plan to expand to over 500 stores in 5 years.
Our next question comes from the line of Wendy Huang from Macquarie.
So my question is still about your warehouse and also the margin impact. So with you adding only like 29 warehouses versus 81 in the fourth quarter, should we expect this deleveraging effect to ease a little bit in the second quarter? In other words, should we expect the second quarter non-GAAP net margin to be slightly better than Q1? And also related to that, I noticed that in your CapEx breakdown, you mentioned that you incurred RMB 1.3 billion for the land and construction versus RMB 2.5 billion for other CapEx. Can you provide some color on the RMB 2.5 billion? Is that mainly for the equipment and also automation?
Sure. Yes. So to your first question. Your suggestion was right, we are seeing better utilization in Q1. And also within Q1, we see improvement on a monthly basis. But we do have other additional warehouses becoming available in the second quarter. So overall, we do expect the utilization and capacity -- the capacity expansion will be more in line with our business growth. So the margin trend for our external logistics business will improve on a quarterly basis and clearly should be on a positive gross margin level by the end of this year. And in terms of CapEx, we did purchase quite a number of other equipment, including servers and also our JDX program, so yes, a number of other automation and online warehouse equipment, all of that. It was a pretty concentrated quarter of those purchases.
Our next question comes from the line of Tian Hou from T.H. Capital.
I have a much macro picture -- macro question. So as cell phone become more mature in terms of adoption, also in terms of hardware standard in each cell phone is so really smart, so the cell phone replacement cycle has become longer. So cell phone market as a whole, the replacement or purchase new phone, those kind of needs is slowing down. So I wonder how JD is going to deal with such a longer-term issue. And also, in the apparel sector, what's JD's strategy to grow in this sector? And one -- between 2, you choose 1 platform is kind of harsh. And is there any other strategy to really -- to move the sector forward?
[Foreign Language]
Yes. So we acknowledge the mobile phone industry may see longer replacement cycles, but we have also anticipated that for quite couple of years. We have not only continued to grow the business online, but we also opened JD Home, an off-line franchise store model to really use omnichannel approach to expand -- further expand our market share. So regardless of the industry growth, we are confident that we can continue to gain market share because we have been a leader. We -- recall we have also mentioned in the past, when a retailer become a category leader, it can normally actually grow even faster than the rest of the industry because of the consumer mind share and because of its economies of scale providing advantages both in procurement and in the retail coverage. So this is -- has -- we have clearly demonstrated this pattern in the categories where we have enjoyed market leadership.
[Foreign Language]
So back to apparel, Richard mentioned that we -- historically, we had encountered this kind of competitive tactics. So the key is if we have customer experience, you have -- the customers are with you, then there's always breakthrough. And in addition, as we mentioned in the past, these kind of practices are hugely unpopular with merchants and brands. And so with our past experience, the impact should be short term, but it will take a few quarters to recover. Right now if you look at the brands, many of them have already working with us, either directly or indirectly, through multiple channels so we can revisit that in the following quarters.
[Foreign Language]
Right. So we have seen brands coming back every quarter, but it will take a couple of quarters -- a couple of more quarters to recover. And as long as we have good customer experience, good traffic, good reputation, we can win back these consumers. Also, once again, because it's hugely unpopular with the brands, and we have seen in the past, when any single channel taking brands as hostage, there will be very different consequence down the road that in the end will not be in the best interest of everyone, including the platform itself.
[Foreign Language]
Yes. You can see that many, many Chinese local brands that are taken hostage by the large platform are taking actions to seek other alternative channels. One example is the WeChat Mini-Program. We can see all of those brands are very, very eager to open their WeChat presence and expand their channel diversity. So by the time when this -- the power of the platform with the rest reach a certain inflection point, we believe it will be the time for us and other channels to regain the brands and regain our consumers.
[Foreign Language]
Yes. We believe this is a wake-up call for the brands, recognizing that overly relying on 1 platform is very, very dangerous to their own long-term growth and health of the business. So with that, through our interaction with the brands, we are even more confident that the current situation will be temporary and that will be reversed in the longer term.
Our next question comes from the line of Shi Jialong from Nomura Securities.
Richard, Sidney, Ruiyu, [Foreign Language] I would like to ask management about the e-commerce startup, Pinduoduo, how do you think of the potential and the sustainability of this group e-commerce model? And we know Pinduoduo has been about to leverage WeChat social graph to grow its users and GMV, so I just wonder if you guys saw any impact from Pinduoduo on your WeChat entry? And also, my second question is a follow-up on Vipshop partnership. In the investment agreement JD signed with Vipshop, JD -- I think the agreement says JD will assist Vipshop to achieve certain annual GMV target. So I just wonder what this GMV target is? And whether you think this target is still achievable based on the latest performance of Vipshop's entry?
[Foreign Language]
Yes. So if you look at Pinduoduo's top 10, top 100 SKUs, you see there's very, very limited overlap to JD's product offerings. So at this point, we can tell you that there's very limited, if any, impact on JD.
[Foreign Language]
Yes. So if you look at the product characteristics of Pinduoduo, you can see most products are really selling at rock-bottom prices with varying qualities. And for JD, we pursue high-quality products at good price. So very, very different product characteristics and very different customer base. And we do have our own similar group buying model on the WeChat platform and the product selection is also very different. Our product selection is tailored to quality and the middle-class consumers.
[Foreign Language]
Yes. So regarding Vipshop, as we mentioned earlier, we are very pleased with the initial progress and everything is on track. We did not disclose the GMV target and it's also quite early to project whether we will achieve such a GMV target or not.
Our next question comes from the line of John Choi from Daiwa.
I have 2 questions. First of all, I'd like to ask your thoughts on the advertising revenue. We do understand it's been growing very nicely. Over the longer term, let's say, 3 to 5 years down the road, how do you -- how big do you think advertising could be because if you look at your global peers, it seems like advertising has been one of the fastest-growing parts within the overall revenue. So I'd like to know -- your thoughts on this. And my second question is just a follow-up on the WeChat Mini-Program. You mentioned, Sidney, on the prepared remarks it's already adopted by thousands of merchants and brands. So I mean, if in terms of -- for JD, how would we really benefit from this in terms of GMV or the economics?
[Foreign Language]
So as I mentioned on the last earnings call, even though our overall GMV is around 1/3 to 1/4 of our closest -- our competitor, but advertising revenue is probably only 1/10 or even less. So we have huge potential to grow our advertising business. And the-- in particular, when we regain our apparel category, which is a ad-heavy category, we can also expect additional boost to our advertising revenue. At this point, without this category, we're already seeing very robust ad growth driven by our AI technologies and also very extensive user data and brand data so we are very optimistic on the ad business. On the Mini-Program, we actually officially launched only a little over a month ago. So right now, it's still in the quite early stage. Some of those Mini-Program adopters are our existing merchants. So they will sell the products very much like they are selling on JD platform. So they will continue to enjoy all the support and tools from JD, such as logistics, advertising yet they can also manage their own user and their own customers. There are other merchants that are not currently on JD platform, but they can also use the JD Mini-Program to open shops on WeChat. And we have a different collaboration model with them including, again, some of the infrastructure offerings, some of the membership and also user for the -- for that particular brand. So we have some early experiment, but it is still quite early in this overall initiative. So we'll update you more in the following quarters.
Our next question comes from the line of Grace Chen from Morgan Stanley.
My first question is on the 3P logistics business. I just need to understand the margin. What would be the -- what's the -- how would the strong ramp-up in the 3P logistics business change your cost structure and margin profile? And what's your target margin for the 3P logistics business in the longer term? And my second question is about the contributions from the 7Fresh stores. What's the revenue contribution from these offline stores this year and maybe next year after a strong ramp? And also, similarly, I'm interested to understand how do you think about the target margin profile for these off-line stores, particularly in the longer term? And how would that impact the overall margins?
Yes. On 3P logistics, we believe because we are offering end-to-end supply chain management services, which is beyond traditional express delivery companies, so we believe in the longer term the margin should be somewhat better than the existing top logistic delivery companies in the world. So you can look at that, which basically will point to mid- to high single-digit operating margin. For 7Fresh, it's -- honestly, it's quite early to -- right now, it has very little contribution to our overall revenue. We are also still debating the future expansion, whether through partnering with our off-line retail partners or opening our own stores. Really it's still a work in progress, so it's still too early to project the margin profile and revenue contribution for this business.
[Foreign Language]
Yes. JD Logistics is the only player at this point in China that can cover the entire spectrum of logistics services. Our competition generally only cover one of those areas, whether it's logistics or warehousing services. And JD covers an integrated full supply chain logistics. And also we can handle the large parcels, small, medium parcels, cold chain, O2O, last mile. And again, we are the only comprehensive service provider for logistics services in China.
[Foreign Language]
So we can say that, at this point, there is no head-to-head competitor in this business in the real sense. And also in addition to our third-party platform merchants who are adopting our services, there are also increasingly -- other business partners outside of JD's current business are increasingly using JD Logistics services.
Our next question comes from the line of Billy Leung from Haitong International.
Just touching back on a few things to discuss. Just on the warehouse again, could we just get an idea of digitization rate, I guess, for the past 2 quarters so that we can sort of gauge what efficiency we should expect in the next few quarters? And the second question is just touching on the quarter 2 revenue guidance. We are seeing a slowdown in growth. I was just wondering if in terms of categories, is there any specific categories, which is causing this slowdown? Is it the apparel? Or is it something that we don't know?
Yes. I think our revenue guidance is generally in line with our prior growth pattern. Q2 last year was a very seasonally high quarter, so the base was very high. As we continue to grow with a higher and higher base, growth rate could be slightly lower than the previous quarter. So the current guidance, we believe, are still very healthy and very strong, and we clearly hope we can over deliver as we have been. And on the logistics, the question is about warehouse facility utilization again. I think we have discussed and explained this. We do expect even better utilization in the second quarter given it's a seasonally high quarter. But we will, at the same time, continue to expand the facilities because this is still in an investing phase for this business. So we are not in immediate pursuit of full utilization like we did in the past when we operate only our internal businesses, which is a lot more predictable. So you will see a few quarters of somewhat extra capacities that are really prepared for business expansion. But as I said, the extent of this overcapacity has been managed down every quarter. So you will see improvement throughout this year.
Our next question comes from the line of from Wang Xiaoyan from 86Research.
My question would be on advertising. So recently, we noticed that you launched the new more version of mobile app with personalization on your home page. So just wondering, how do you expect this personalization would impact your, for example, the customer acquisition, time spend or eventually the conversion and the GMV? And particularly, for the upcoming June 18 sales, do you expect this personalization could contribute to this big promotion day?
Yes. The personalization will be -- is already in process. There will be multiple versions. So right now what you see is only the very first new version, and we do expect more upgrades before June 18 shopping season. And it will take at least a few quarters through multiple iteration to get to the -- a very, very good state where consumers can really experience very differentiated recommendations. But it will take time. But I can tell you, initial results are positive. But it's really too early to claim victory at this point.
Our last question comes from the line of Gregory Zhao from Barclays.
So recently, I think, during an interview Richard mentioned that in the long run JD will adopt more robot and AI technology to improve the company's overall automation. So just want to understand, for the short term and the long term, what's the margin implication from such process? And I have a quick follow-up question on our traffic. So just want to understand what the percentage of your current user traffic or new user acquisition from the third-party apps, so specifically like WeChat and Baidu?
[Foreign Language]
Yes. So on the automation investments, yes, we -- there will be short term investments, as you can see, in R&D spending in Q1 increasing 70 basis points. But we believe this will reduce our long-term cost and operating -- improve operating efficiency as we -- these robotic technologies will help our warehouse efficiency and also delivery efficiency. So it is investment that we believe are worthwhile for our long-term cost advantage.
[Foreign Language]
Thank you. 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, operator, and thank you for joining us today on the call. Looking forward to talking with you in the future. Thank you.
Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.