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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Ladies and gentlemen, good day everyone, and welcome to Vipshop Holdings Limited’s Second 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.
Thank you, operator. Hello everyone, and thank you for joining Vipshop’s second 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 recent expectations, assumptions, estimates and projections about Vipshop Holdings Limited and 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/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. Shen?
Good morning and good evening, everyone. Welcome and thank you for joining our second quarter 2018 earnings conference call. We are pleased that our active customers grew by 6% year-over-year in the second quarter with continued improvement in customers’ business. Our collaboration with Tencent and JD are starting to show initial results. New customers from these channels accounted for 24% of our total new customers in the second quarter. Our JD flagship store currently has around 1.5 million followers and our WeChat mini program is becoming a strong channel for new customer acquisition. New customers from the mini program increased by over five times quarter-over-quarter. We are also pleased to see improvement in its conversion rate.
Our core strength lies in this constantly telling, recently, we launched a few new initiatives to deepen our expertise in this field. For example, we launched APT called Wei pin Hua, which is a specialized platform for wholesalers. Through Wei pin Hua, wholesalers and the WeChat merchants can purchase offseason discounted inventory in book to be sold through their own channels. This is an extension of discounted retailer model, which will help Vipshop and our suppliers clean inventory more efficiently. With Wei pin Hua, we can truly provide our brand partners with full product cycle inventory management service, helping them resolve their inventory issues more competitively.
Further, we added a new channel called [indiscernible] at over 70%. This is another step we are taking to bring products with great value to our customers.
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 the finance results.
Thanks, Eric and hello, everyone. In the second quarter of 2018, driven by the increase in shopping frequency, our average revenue per customer increased by 12% year over year. This is a testament of the loyalty of our customers and our operational capability. We are keenly focused on serving our customers and providing them with a superior shopping experience. Therefore, we are increasingly focused on our merchandising strategy. As we continue to offer differentiated products at great value, we are confident we will expand our market share in the long run.
During the quarter, our Super VIP loyalty program continued to expand its customer base, adding around 430,000 paid members. As of the end of June, around 1.9 million customers enrolled in our Super VIP program, which represents a 30% increase quarter over quarter. In addition, we recently launched a joint membership program with Tencent Video. Now, our Super VIPs are able to enjoy Tencent Video’s annual membership at a deep discount, offering them even more value. In order to capture more growth opportunities with the WeChat ecosystem, we recently launched around 400 official WeChat mini programs for our brand partners. Further, our initiatives to focus on male customers and post customers are starting to bear fruit. In the second quarter, the number of male customers grew by over 35% year over year. Conversion rate for both mail customers and post customers increased by around 10% year over year, which was driven by more precise targeting as a result of our improved algorithm.
Turning to logistics, we continued to invest into our warehouse and capacity in the second quarter, adding another regional logistics hubs in China. With this addition, we currently have six regional logistics hubs located in Guangdong [indiscernible]. As of June 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.
During the quarter, we delivered around 99% of orders through our own last mile delivery network, up from 95% in the prior year period. More than 81% of customer returns were handled directly by our in-house last mile delivery network, up from 68% in the prior year period.
Turning to our Internet finance business, approximately 5.8 million active customers used our consumer financing, during the quarter, which accounted for around 22% of GMV. As of June 30, 2018, the total balance of credit outstanding to customers was approximately RMB4.4 billion and the total balance of credit outstanding to suppliers was approximately RMB1.6 billion. Going forward, we will continue to work closely with Tencent and JD in order to realize potential, the partnership presents for all three companies. We are focused on our merchandising strategy aiming to bring the best parts to our customers at the most favorable costs.
Overtime, this will create more differentiation and further solidify our leading position in Chinese online discount retail space.
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 second quarter of 2018 increased by 18.4% to 20.7 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 second quarter of 2018 increased by 4.8% to 4 billion from 3.9 billion in the prior year period. Gross margin was 19.5% as compared with 22% in the prior year period, primarily attributable to our investment into promotional activity.
Fulfillment expenses for the second quarter of 2018 were 1.9 billion, as compared with 1.6 billion in the prior year period, primary reflecting an increase in sales volume and number of orders fulfilled. As a percentage of total net revenues, fulfilment expenses decreased to 9.1% from 9.4% in the prior year period. Marketing expenses for the second quarter of 2018 were 900 million as compared with 752 million in the prior year period.
As a percentage of total net revenue, marketing expenses remained stable at 4.3% year over year. Technology and content expenses for the second quarter of 2018 were 511 million, as compared with 448 million in the prior year period. As a percentage of total net revenue, technology and content expenses decreased to 2.5% from 2.6% in the prior year period.
General and administrative expenses for the second quarter of 2018 were 615 million as compared with 579 million in the prior year period. As a percentage of total net revenue, general and administrative expenses decreased to 3% from 3.3% in the prior year period. Our income from operations for the second quarter of 2018 was 400 million as compared with 622 million in the prior year period. Operating margin was 1.9% as compared with 3.5% 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 595 million as compared with 888 million in the prior year period. Non-GAAP operating income margin was 2.9% as compared with 5.1% in the prior year period. Our net income attributable to Vipshop shareholders for the second quarter of 2018 increased by 76.4% year over year to 682 million from 386 million in the prior year period.
Net margin attributable to Vipshop shareholders increased to 2.3% from 2.2% in the prior year period. Net income attributable to Vipshop shareholders per diluted ADS increased to RMB0.99 from RMB0.64 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, net of tax, and gains on disposal or revaluation of investments net of tax, was 577 million as compared with 673 million.
In the prior year period, non-GAAP net margin attributable to Vipshop shareholders was 2.8% as compared with 3.8% in the prior year period. Non-GAAP net income attributable to Vipshop shareholders per diluted ADS was RMB0.84 as compared with RMB1.09 RMB in the prior year period. As of June 30, 2018, our company had cash and cash equivalents and restricted cash of 6.4 billion and short term investments of 2.1 billion. For the second quarter of 2018, net cash used in operating activities was 502 million.
Looking at our business outlook for the third quarter of 2018, we expect our total net revenue to be between 17.2 billion and 18.1 billion, representing a year-over-year growth rate of approximately 15% to 18%.
With that, I would now like to open the call to Q&A.
[Operator Instructions] Your first question comes from the line of Alicia Yap from Citigroup.
I have a question regarding the collaborations with the Tencent and JD, could you help us reconcile the 24% of the new user coming from these two channels this quarter, which we thought is a positive signal and even it takes time to ramp and come for and why couldn't we see the revenue growth rate either stabilizing or even reaccelerating, instead, I think, from the 3Q guidance that you provide, it actually shows a pretty surprised deceleration. So could you help us to analyze what happened to your user base and also the new user acquired from those channels. Any color would be appreciated. Thank you.
[Foreign Language]
[Foreign Language]
So Alicia, in the second quarter, we did receive help in terms of new customers from Tencent and JD, but because these customers are new to Vipshop, their ticket size and shopping frequency is lower than our existing customers, but the revenue contribution is not shown as significantly as the customer growth in the second quarter. As we continue to work with Tencent and JD, we expect to get new customers from these channels consistently and due to our CRM expertise, and our merchandising capability, we do believe that overtime, we will be able to turn these new customers into high quality existing customers and overtime, we will see higher revenue contribution from these new customers acquired from Tencent and JD.
Your next question comes from the line of Eddie Lo from Merrill Lynch.
I also have a follow-up question on new customers. Actually not so much about the new channels like JD and Tencent. I’m more curious on your strategy in acquiring new customers for modern channels, perhaps, mobile and other channels. If we look at the marketing expense as a percentage of sales, because it's a year ago, still you're quite stable. So should we expect some leverage on sales and marketing going forward, if we can rely more on JD and Tencent for finding new customer traffic. Any thoughts on that front would be great.
[Foreign Language]
[Foreign Language]
So Eddie, at this point in time, we continue to invest into other channel like just Tencent and JD. So we continue to invest into other digital channels, also doing mobile phone installation and working with app stores. And so due to Tencent and JD, we do have higher hopes in terms of customer acquisition and we do believe that overtime, it will be more meaningful. However, in the interim, we’re still investing into other channels and we do expect to see operating leverage over the long term.
Your next question comes from the line of Wendy Huang from Macquarie.
Can you share some detail about the retail demographics of those acquired through the JD and Tencent channels, i.e., the [indiscernible] and whether those users are complementary to your existing user base? And also a small question about the Wei pin Hua you mentioned in the prepared remarks. Can you give some color on revenue and also fulfilment cost in this new product?
[Foreign Language]
[Foreign Language]
So Wendy, regarding the first question, regarding the mini program customers and what they’re like, so the mini program customers are quite similar to our own. It’s heavier to our contribution and our core app and the new customers have lower ticket size comparing to those of our native app, but as we mentioned, as we continue to work with them and show them better products and operationally no better of what these customers want, we will continue to improve the product offering for these new customers and also improve their overall spending on our platform. We did try some group buys and things like that over the WeChat channel over the past few months and what we noticed is that, although customer growth was quite fast, the quality of those customers is not there. So I think we had some learnings from there and over time, we will be able to more sustainably gain quality new customers from the WeChat channel.
[Foreign Language]
So Wendy, regarding the second question about waiting time and the fulfillment expenses, so with waiting time, the product won’t be sitting on our warehouse, but they will be using our last mile delivery service from [indiscernible]. So in terms of the delivery component, there is one left and also the cost should be lower than our core business.
Your next question comes from the line of Binnie Wong from HSBC.
My first question is on the new users that we acquired from Tencent and JD channels. What is our strategy down the road to raise the frequency and size eventually to turn them into with our core resource and also in terms of the beta sharing, what are the biggest, I guess, most important for user to come into to understand why they did not buy too. It’s not just that they come in and then, especially for customers that have left the channel, will they just come and visit, but they did not essentially at the product end of the basket. So for those kind of customers on our core platform, do you have access to build through realized data, but then from Tencent and JV channels, any sort of data that they will share back with VIPS so that we can target those customers that you’re better targeting.
And my second question is [indiscernible], in terms of the margins that you’re seeing here, because we understand that margins have been on a downtrend, continues investing, how do we see the trends to proceed into the second half, how should we think about the margin trends?
[Foreign Language]
[Foreign Language]
So, Binnie, with JD, because it’s not our intention to bring them to our own app, so they will just continue to shop via JD. And in terms of Tencent, we do get certain customer tax on WeChat in terms of customer demographics such as gender, age and so on. And for that, we will be able to better target these customers with different wordings of landing pages, showing them different products, depending on what our big data team and our owners think that is suitable for those customers.
Over time, that will help a lot with conversion rates and also in terms of WeChat, one good thing that it has there are dropdown users, meaning, once you’ve clicked into the WeChat and enter Vipshop app, even if you didn’t buy your type, every dropdown will have entered Vipshop’s mini program in the path. So we will be able to reach those customers and we’ll continue to get [indiscernible] demographics and we also have our public accounts in the WeChat ecosystem. So we’re trying to do better in terms of connecting the same customers in different ecosystems such as WeChat mini program public account and our only app and overtime, as we better understand those customers and their shopping behavior in each channel, we’d be able to better convert them into our customers and also improve their conversion rate on products over time.
And Binnie, let me take your second question about margins. Well, Q2 2018, our margin came down due to a couple of things. One, we reclassified costs related to our third party logistics business from fulfilment expenses to cost of revenue, which had a 1.1 percentage point impact on gross margin for the current quarter. And then secondly, during the second quarter, we had a few major promotional events namely April the 19, May the 20 and June the 16. In those events, promotional events, we offered deeper discounts to our customers. Going forward, we will focus more on our merchandising strategy and our buyers will try to negotiate better deals with the suppliers, so that we can improve on our gross margins in the long term. But in the next few quarter, there might be some fluctuations in our margins, but over the long term, we are quite confident.
Your next question comes from the line of Xiaoyan Wang from 86 Research.
Two questions here. First one is regarding your wholesale business, Wei pin Hua, so how will you recognize wholesale business GMV? Will it be in the total GMV? And also on the revenue side, is it the 1Q revenue or you will recognize in the other revenue line?
And the second question is regarding your cash flow this quarter, operating cash flow is again negative and I think the most – the biggest impact is still the comparable items and which lead to a negative free cash flow. So, can you provide some color on the outlook of the operating cash flow and free cash flow in the quarters ahead?
Okay. Let me take your questions. Well, for the revenue generated from our Wei pin Hua business, we will recognize gross sales as a revenue. And for your second question, on operating cash flow, well, there were a couple of things that resulted in a negative cash flow in Q2. Number one, there was decline in our margins and secondly, starting from the second half of 2017, payment from customer returns are deposited directly back to the customers’ original payment method, instead of being returned to their Vipshop wallet. This change has resulted in a decrease in our advance receivables from third party platforms, which impacted our operating cash flow.
Going forward, this was the second reason, is actually a temporary thing. And we’re expecting the impact from that to go away in the next one or two quarters. And also going forward, as I said earlier, as we focus more on our merchandising strategy, we will push our buyers to negotiate better deals, higher margins with the suppliers in order to improve our gross margin. So, operating cash flow, I think, will come back to its normal level or will start to go up in a few quarters.
Your next question comes from the line of Alex Yao from J.P.Morgan.
I think that you guys mentioned quite a few initiatives that were already done in relation to the integration with the Tencent and JD platform. Can you give us a roadmap in terms of the, for the next 12 months, what else would you be doing to further improve the efficiency of the integration or the conversion ratio from traffic to transactions?
I think a follow-up and related question is that, the market generally expects your revenue to accelerate in the next one or two quarters, given the relatively still in user base between you and these two partners. Is that assumption at risk or is it still reasonable. Thank you.
[Foreign Language]
[Foreign Language]
Alex, on JD, our goal is to sell more merchandise. So that’s why we’re going to different entries on JD, switched from one and changed on account page to four different entry points, including that in the same panel at the original, but also in terms of categories and flash builds, now, you’re able to see Vipshop entry point. So we’re continuously learning about the channels and different channels within the JD app, trying to gain higher efficiency and more revenue from the JD customers.
In terms of Tencent, as we’ve mentioned, we already are seeing new customers coming in and we’re also exploring for new ways to gain more customers from Tencent and also the WeChat team and the mini program team. So in terms of how we view growth, we are pretty confident that in the next 12 months, we’re able to meet our expectations in terms of new customer acquisitions from Tencent and JD, but if we want to see a lot more than that, then we would have to continue to work with them to find a new way to grow and an effective way to gain new customers.
Let me take your second part of the question. Well, we are acquiring lot of new customers from both Tencent and JD. But you know what, the new customers, their ARPU are relatively low and it takes time for them to improve or increase their ARPU or improve on their average basket size. And so it takes time for the new customer acquisitions to have meaningful impact on our revenue. So it’s hard to say, if in the next couple of quarters, our revenue growth will start to reaccelerate, but going in the long run, I think we will see meaningful or a significant impact on our revenue from the new customer growth from the two partners.
Your next question comes from the line of Ronald Keung from Goldman Sachs.
I have a question more on the business model. I think we’ve talked a lot on the channels, how to attract customers. But more back to our basic business model, how do we see our core apparel business sort of in terms of the focuses on, for example, off season. Second would be, how are we, in our strategy for marketplace, just share from a 1P to a 3P model, and even possibilities of, for example, cooperation with any offline players, it could be an asset light, but some cooperation and besides apparel how are we with our category expansion, although we are now focused on apparel, would like to hear your thoughts.
[Foreign Language]
[Foreign Language]
So Ronald, to answer your questions, apparel is our core and why customers comes to us in the first place. So we will continue to focus on this as our core customers, attracting more customers coming to us, because we have the best selection of apparel at the most favorable prices. And for e-commerce, obviously, you have to have one category. So, we already have a variety of categories and we also a marketplace model although a small contribution. So going forward, this model won’t change too much. We will have the other categories, even though the reason that customers come to us is mainly because they are coming to us for the selection of apparel on our platform. But we will continue to have a marketplace and other categories in order to meet customer demand.
We are a retailer, so we are deeply focused on heavy and deep discounts, getting back value to our customers. Regarding offline, we’re learning about offline business model and we are exploring different opportunities.
Your next question comes from the line of Jerry Liu from UBS.
[Foreign Language] My question is on competition. Just want to get an update on how we see the competitive landscape most recently with the major players, including Ali, JD and [indiscernible], but also as we do more on JD’s platform and on in Tencent mini programs, how do we see some of the other competitors that are on those programs and then the third party flagship stores and whether that changes some of our promotions and even the business model a little bit going forward.
[Foreign Language]
So Jerry, there is always competition and in the future, there is going to be competition, but our positioning is that we are a discontent retailer focused on the apparel category and that’s where our strength is at. So we’ll continue to focus on our core and leverage our expertise in our core categories and the deep discounts field to offer back value to our customers and we believe that with this strategy in mind, we will continue to gain and retain these customers.
Regarding your question about the different competitors that are emerging from the WeChat ecosystems, we believe that the coupon model is quite different from us. And as we’ve mentioned in previous remarks, drive the group by model and didn’t find it to be too suitable for our business model and the kind of customers that we want to serve in the long term. So in terms of ticket size, we are around RMB300, which is quite a bit higher than those of the coupon competitors in the WeChat ecosystem.
Your next question comes from the line of Monica Chen from Credit Suisse.
I have one question regarding our paid membership program, so which we actually see quite decent growth for this quarter. So I want to understand how many of the users who are actually converted into the paid members after their free trial periods and how is the retention for that? And also for this membership, how is this our service different from some of the other membership products launched by other e-commerce platforms and how do we expect this service to further improve our users’ thickness and ARPU trend in the future. Thank you.
[Foreign Language]
[Foreign Language]
So Monica, we’re seeing quite good results from our super VIP program. And on average, the ARPU from these customers are 50% higher than those of the non-super VIPs. And as you mentioned, we do have a lot of trial in the first program for three and they have the option to become a paid member at the end of their trial period. And the current conversion rate we have seen in that, around 18% to 20% from trial to becoming a paid member. So as we disclosed, we had around 30 million customers total in the second quarter and only 1.9 million super VIPs. So we do believe that there is a lot of room to continue to convert our existing customers into super VIP paying members and over the long term, we convert to improve their ARPU and continue to improve their stickiness on our platform.
Next question comes from the line of Natalie Wu from CICC.
I have two here. First one is how do you see the competition from some newly emerging players such as [Foreign Language]. I know you launched that, so just wondering how do you prepare to with merchants, if you know those merchants are of very different nature versus those existing ones. And also how to compete with those existing players, I just mentioned before those are like mainly backed up by those PC. Also given that the VIP in town, independent app, just wondering will it impact heavily to accumulate users for this independent app, will this impact your margin in the upcoming quarters?
Second question, actually you have very good cash flow and you have very loyal customer group and several nice data program which can go into, given the example of the peers in the private market, but actually your valuation is kind of depressed in the secondary market. So just wondering if there are any chances that you will consider taking your company private?
[Foreign Language]
[Foreign Language]
So Natalie, our goal is to solve problems for grants. Our consignment works quite well. However, we do return the products that we can’t clear to our grant partners and the return products are still an issue for those grants and they struggle to clear the inventory that is not able to be cleared by the Vipshop platform. And on the other hand, there are lots of wholesalers and WeChat merchants and mini merchants out there, looking for products, but they also don’t have a lot of reliable and trustable sources to source those products and our goal is to connect those two groups, the grant and the number of sellers and the WeChat merchants. We are strong in the discount retail space and that’s how we are able to grow the size today. So we certainly recognize that there are some other players doing similar things out there, but we work with them directionally and at the end, it’s clearing inventories for grants and by launching that, we are able to solve them, to help them solve their inventory issues and we do believe that as soon as we enter this space, we will be able to capture a lot of the opportunities within this space. [Foreign Language]
[Foreign Language]
So Natalie, regarding your second question, on whether this would affect margins in terms of marketing expenses, because it’s a business to business model, we are selling to smaller businesses, merchants and wholesalers. We don’t need to do a whole lot of marketing in B2C. So we do believe that in the market as big as China, we likely need around 50,000 users and sellers that use the VIP platform and we don’t need to do a lot of marketing to attract them, but instead, we attract them with good resources and our operational strengths as well as ease of using our apps. [Foreign Language]
[Foreign Language]
Natalie, we’re currently not thinking of taking the company private.
Thank you. That’s all the time we have for questions today. I’d like to hand the call back to today’s presenters for their closing remarks.
Thank you all for taking the time to join us and we look forward to speaking with you next quarter. Thank you.
Thank you.
Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.