Earnings Call Transcript - BZUN Q3 2022

Operator, Operator

Good morning, ladies and gentlemen and thank you for standing by for Baozun’s Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After management’s prepared remarks, there will be a question-and-answer session. As a reminder, today’s conference call is being recorded. I will now turn the meeting over to your host for today’s call, Ms. Wendy Sun, Senior Director of Corporate Development and Investor Relations of Baozun. Please proceed, Wendy.

Wendy Sun, Senior Director of Corporate Development and Investor Relations

Thank you, operator. Hello, everyone and thank you for joining us today. Our third quarter 2022 earnings release was distributed earlier and is available on our IR website at ir.baozun.com as well as on Globe Newswire services. They have also posted a PowerPoint presentation that accompanies our comments to the same IR website, where they are available for download. On the call today from Baozun, we have Mr. Vincent Qiu, Chairman and Chief Executive Officer; Mr. Arthur Yu, Chief Financial Officer; Ms. Tracy Li, our Vice President of Strategic Business Development; and Ms. Sandrine, President of Baozun Brand Management. Mr. Qiu will review the business operations and company highlights, followed by Mr. Yu, who will discuss financials and key operating metrics. They will all be available to answer your questions during the Q&A session that follows. Before we begin, I would like to remind you that this conference call contains forward-looking statements within the meaning of the Securities Exchange Act of 1934 and the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements are based upon management’s current expectations and current market and operating conditions and relate to events that involve known or unknown risks, uncertainties and other factors, all of which are difficult to predict and many of which are beyond the company’s control, which may cause the company’s actual results to differ materially from those in the forward-looking statements. Further information regarding these and other risks, uncertainties or factors is included in the company’s filings with the U.S. SEC and the announcement on the website of Hong Kong Stock Exchange. The company does not take any obligation to update any forward-looking statements, except as required under applicable law. Finally, please note that unless otherwise stated, all figures mentioned during this conference call are in RMB and the comparisons are on a year-over-year basis. It is now my pleasure to introduce our Chairman and Chief Executive Officer, Mr. Vincent Qiu. Vincent, please go ahead.

Vincent Qiu, Chairman and Chief Executive Officer

Thank you, Wendy. Hello, everyone and thank you all for your time. Despite the ongoing challenging environment, we are encouraged by the resilience of our business. As shown on Slide #2, we delivered double-digit growth in several categories, including luxury, fashion apparel, and FMCG. Moreover, our digital marketing and IT solutions revenue increased by 22%. While product sales continue to decline as planned as we keep optimizing our distribution model, service revenue grew 4% year-over-year. Business development during the quarter was on track with a net addition of seven brand partners for store operations. For our existing client base, it’s worth noting that our business development also reflects higher engagement in company channels and more value-added services. Our integrated omni-channel operations help brands to timely identify evolving e-commerce trends, thus enhancing resource allocation efficiency. During the quarter, over 42% of our brands engaged with us on an omni-channel approach. We continuously develop new features and tools to augment bundled value-added services. This quarter, we launched a short video cleaning tool, which automatically converts long video or live streaming records to short videos. We also co-developed with a marketplace an AI-based outbound calling system to proactively communicate with targeted brand customers. This helps us improve purchasing frequency and conversion. We expanded our regional service centers to more cities recently and added new functionalities to them, supported by our customer service management systems or S-ANY as a backbone. We improved not only service quality but also efficiency. The new module named S-ANY, which means 'event anywhere,' has been developed for centrally managed content creation during the quarter. Despite the short-term headwinds from the macro environment, we are glad to see that brand partners still consider China one of the most critical markets with a lot of potential. We continue to see a trend of digital transformation, such as the rapid convergence between online and offline or OmO. Along with the digital transformation trend and our emphasis on a China-for-China strategy, brands are investing in IT solutions for the long term. As such, our technology-related revenue sees notable growth with a sound pipeline for additional growth. In light of the strong demand, we officially launched BOCDOP, a Baozun omni-channel digital operation platform, a packaged solution with powerful customization capabilities. BOCDOP is centered on multiple channel order fulfillments and delivers powerful omni-channel D2C, data intelligence, and decision support functionalities to our brand partners. Following many years of nonstop investment in technology, we started expanding upstream and aim to evolve into a technology-driven omni-channel commerce player. Early this November, we announced our acquisition of Gap Greater China, one of the largest American specialty apparel brands. Along with this acquisition, we launched Baozun Brand Management, a new line of business that we see as a strategic addition to our core e-commerce services and technology offerings. The acquisition is a good fit to develop BBM since we have worked with the brand for many years. We are optimistic about it and believe in it. It has only been a few weeks since our announcement, and we are still in the process of finalizing the acquisition. It is encouraging that since the news was shared, many other brands have come to us to discuss the China-for-China strategy and our technology-driven approach. It has become obvious that our brand management offering clearly can add more to our value proposition and differentiate us from traditional service providers. While it will take time and hard work to fully realize our vision, we believe that a closed-loop demand to supply value chain, as well as integrated offline and online commerce, will make brands unique and much more successful than before. I shall now hand over the call to Arthur to go over our financials. Thank you.

Arthur Yu, Chief Financial Officer

Okay. Thank you, Vincent and hello everyone. Please turn to Slide 4. During the quarter, our total GMV increased by 16% to RMB18.6 billion, mainly due to the outstanding performance of one leading electronics brand. Excluding this brand, the adjusted GMV would have been flat on a year-over-year basis. Total revenues declined by 8% to RMB1.7 billion, of which product sales declined by 29%, while service revenue increased by 4% compared with the same period last year. Now, let’s turn to Slide #5 for a breakdown of revenue. Despite a decline in total revenue, several categories, including apparel and FMCG achieved double-digit growth. The value-added services showed more resilience in this quarter, where digital marketing and IT solutions increased by 22% and warehousing and fulfillment service revenue declined by only 7%. Overall, the contribution from value-added services increased to 23% of total revenue in this quarter. Please turn to Slide #6. In this quarter, our cost of products decreased by 30% to RMB415 million, mainly due to continued efforts in optimizing our product sales business. As a result despite a reduction of 29% in product sales revenue, the gross margin for product sales improved by 175 basis points to 16.6%. Moreover, our overall gross margin improved by 800 basis points to 76.2% driven by a combination of a higher service revenue mix and improving gross profit margin. Now turning to Slide #7, our non-GAAP income from operations was RMB17 million during the quarter, representing a non-GAAP operating profit margin of 1%. Non-GAAP net income was breakeven this quarter, mainly impacted by unfavorable exchange rate movements. Once again, we have prepared waterfall diagrams depicting our analysis of how our top line and bottom line evolved year-over-year. As a reminder, this analysis is unaudited and should solely be used as supporting members to aid discussion. First, on Slide #8, this diagram shows our net revenue walk from quarter three 2021 to quarter three 2022. In red, you can see the biggest item impacting our revenue this quarter was product sales, as we continued our efforts to optimize low-quality distribution revenue. Revenue from DM and IT services, which we view as value-added services, grew by 22% this quarter. Revenue from warehouse and logistics declined by 7%, mainly due to our decision to divest a subsidiary in the business, which I will address more later. Excluding such investments, revenue from warehouse and logistics should have had a slight increase year-over-year. On a positive note, this initiative led to better profitability. Now please turn to Slide #9 for the indicative walk of non-GAAP operating profits. As mentioned earlier, the combination of higher COVID-related costs and general operating deleverage due to lower revenue resulted in less profit for online store operations businesses across all categories. However, as shown, non-GAAP operating profit from digital marketing and IT improved by RMB30 million year-over-year. In addition, the optimization of low-quality distribution business contributed RMB3 million and profits from the warehouse and logistics business improved slightly by RMB1 million. We also generated a positive savings of RMB3 million from back office cost optimization. In cost optimization, we continue to gain higher efficiencies by centralizing our operating capabilities, rationalizing incentives and consolidating our office footprint. More significantly, this quarter, we selected more cities such as Jinan, Chengdu and Enshi to expand the scope and scale of our regional service center. Now approximately 60% of our customer service staff are located in regional service centers. By placing customer service staff in these regional centers, we have increased service flexibility and agility to better cope with COVID-induced challenges. Moreover, we expanded beyond customer service and added more operating functions at regional service centers and live stream studios. We also further deepened our cooperation with Cainiao to leverage already established infrastructure and network. As you may recall, in the second quarter, we began to manage Cainiao’s warehouses in the apparel category and received business referrals in luxury and premium sectors while also launching the mall solution for some of our key sportswear brands. Motivated by the synergies and after further careful evaluation, we decided to reduce our shareholding in Baobida, a last-mile delivery agency, to minimize duplication with Cainiao. As you may recall last year, prior to our strategic alliance with Cainiao, we invested into Baobida to expand our logistics capabilities. However, now with the Cainiao alliance, we decided to transition our investment from a majority to a minority. Now turning to Slide #10 about our cash flow, as of September 30, 2022, our cash and cash equivalents totaled RMB2.9 billion. In light of macro uncertainty, we continue to improve working capital efficiency. During the quarter, we launched new initiatives to further advance our back-end processes for inventory management, billing, and collection activities. Historically, in order to prepare for the Double 11 festival, the first quarter typically requires peak operating cash flow. This third quarter, benefiting from improvements in our inventory procurement planning, we were able to narrow the operating cash outflow to only RMB113 million compared with RMB740 million a year ago. During the quarter, we repurchased approximately 700,000 ADS for around $6.1 million. To-date, through our share buyback efforts, we have repurchased a cumulative total of $68 million in the last nine months. Lastly, the voluntary conversion into a primary listing status on the main board of the Stock Exchange of Hong Kong Limited became effective on November 1. Baozun is now a dual primary listing company on both the Hong Kong Stock Exchange and the NASDAQ Global Select market. This marks a significant milestone in our capital market journey. Overall, our effectiveness in maintaining operations and supporting our partners’ success during this period of macro uncertainty underscores the durability and strength of our business model. Throughout this year, we prioritized cost transformation and working capital efficiency, and our efforts are bearing fruit in terms of higher gross margin, lower operating expenses, and improved cash flows. The establishment of Baozun Brand Management, along with the acquisition of Gap Greater China, will provide us with good opportunities for future growth. This is my financial review section and that concludes our prepared remarks. Thank you. Operator, we are now ready to begin the Q&A session.

Operator, Operator

Thank you. Our first question comes from Alicia Yap from Citi. Please go ahead. Your line is open.

Alicia Yap, Analyst

Hi, thank you. Good evening, management. Thanks for taking my questions. I have two questions. First, if management can share with us any preliminary insights regarding the consumption sentiment across all channels post-Single's Day. In relation to that, how should we think about the overall GMV and revenue growth for the fourth quarter, and if management also has any preliminary view on the 2023 outlook? Second question is regarding your digital marketing and IT solutions, which are performing well. Can you elaborate a bit on the types of brand customers and the operational metrics, like the take rate, that you can share with us related to this service? Will this revenue line continue to deliver decent growth in the coming quarters? So how should we think about that? Thank you.

Arthur Yu, Chief Financial Officer

Okay. Thank you, Alicia. So maybe Tracy can comment on the Double 11 performance and the consumption sentiment. I can answer regarding the view of Q4 and next year. If that’s okay? Tracy?

Tracy Li, Vice President of Strategic Business Development

No problem. Thanks for the question. I think right now, the Chinese consumer is still largely impacted by COVID-19. In recent two months, from a logistics point of view, there are still many lockdowns affecting operations. But for Double 11, we can see that the overall performance is still under pressure, which means there isn't a significant increase. However, this period is a very important window for us to observe trends across different categories. I can summarize some observations from our core BI system and also from public data. We see that in consumption trends, there are four heated schemes: home improvement, self-care, and sports lifestyle. For example, the sales of the outdoor sports equipment and footwear categories showed year-over-year increases ranging from 8% to 28%. Additionally, you can see that categories including luxury and premium bags and luggage have achieved steady growth over the past four quarters. Among these four areas, we still see opportunities for next year. However, there are also declining trends in categories like fashion accessories and men’s and women’s footwear, reflected in two to three quarters of decline in daily sales and among major promotions. Therefore, we need a steady growth approach to navigate this landscape. Besides the category shifts, we also see platforms focusing more on user retention and new business growth opportunities, such as private domain traffic and membership benefits. All of this enhances our potential to collaborate with brands and platforms on digital marketing and related technologies.

Arthur Yu, Chief Financial Officer

Okay. Thank you, Tracy. Regarding the Q4 outlook, our current view is from the GMV perspective—we see some good momentum in electronics and FMCG. However, we also see significant headwinds in apparel and sportswear. Overall, we believe our Q4 GMV will be in line with the market, likely flat year-over-year. In terms of revenue, we still see the optimization of low-quality product sales continuing unless market sentiment picks up. Therefore, we anticipate a slight decline year-over-year in revenue. The main contributing factor is the product sales which will continue to be optimized. In terms of next year, I think it’s a bit early to comment, because there are still various significant factors impacting the overall macro conditions and COVID policies. However, our view is conservative for next year, and we plan to focus on quality rather than growth. Regarding your second question, Alicia, on digital marketing and IT solutions, we see a strong momentum from our client base. Our brand partners are beginning to focus on medium- and long-term investments in their businesses in China, leading to a strong pipeline for value-added services such as IT solutions and digital marketing. We expect this growth to continue, given the investments we’ve made in technology over the past few years. I believe Baozun is well-positioned to capitalize on these opportunities in the current market.

Alicia Yap, Analyst

Yes. Thank you, Arthur. Thank you, Tracy.

Operator, Operator

Thank you. We will take our next question. Our next question comes from the line of Charlie Chen from China Renaissance. Please go ahead. Your line is open.

Charlie Chen, Analyst

Thanks, management for taking my questions. I have two questions here. The first one is regarding the GMV contribution. In this quarter, the GMV contribution from non-Tmall channels seems to be a bit lower than last year, Q4 2021. Can you explain the rationale and background behind this? What’s the long-term goal for GMV growth between Tmall and non-Tmall channels? The second question is regarding the Gap acquisition and the overall restructuring. Can you provide more color about the progress after you announced the acquisition of Gap? I also see Baozun is transforming from a pure marketing agency to a more comprehensive service company. How long do you expect this transition period to last, and when do you anticipate seeing synergies or integration results moving forward? Thank you.

Wendy Sun, Senior Director of Corporate Development and Investor Relations

Hello. Hey, operator, can you hear me?

Operator, Operator

Yes. I can hear you, loud and clear.

Wendy Sun, Senior Director of Corporate Development and Investor Relations

Okay, I assume the line was just experiencing some technical difficulty. Charlie, do you want to talk about the brand management for the second question? Maybe Sandrine, can you take this one to align together?

Arthur Yu, Chief Financial Officer

Yes, sure. Hello, Charlie. This is Sandrine. Thank you for your question. Regarding the Gap acquisition, it's been about three weeks since we signed the agreement. We are focusing on a thorough understanding of Gap’s functions, which enables us to deepen integration. We are learning from the feedback, confirming our observations regarding the current operations. On one hand, we expect some quick wins in terms of restructuring and cost-cutting due to now managing from a Chinese company perspective. Going forward, we anticipate optimizing many aspects of the business to enhance product relevance and operational efficiency which had previously not been prioritized. The supply chain improvements are one of our main areas, as we have full control of it, allowing us to enhance responsiveness to market trends. Additionally, we plan to optimize the current store portfolio to improve performance rather than simply opening more stores. We believe that with these strategies in place, we can significantly reduce losses in 2023 while reaching breakeven in 2025 and profitability in 2026. Charlie, on your question regarding the Tmall GMV contribution, the trends you’ve seen are impacted by a major electronics brand outperforming in quarter three. Excluding this brand, our non-Tmall contribution has actually increased slightly in the single digits. Our omni-channel strategy doesn't aim to push customers from Tmall to non-Tmall but rather to encourage them to engage with our value-added services. This quarter, we have 42% of our total brand partners operating under the omni-channel model. Thank you.

Charlie Chen, Analyst

Thank you.

Operator, Operator

Thank you. We will take our next question. Our next question comes from the line of Thomas Chong from Jefferies. Please go ahead. Your line is open.

Thomas Chong, Analyst

Thanks, management for taking my question. I have two questions. My first question is, could management share some insights into the changes in domestic versus international brands? My second question is, could management share some updates about the cooperation with Cainiao and our expansion into the Southeast Asia market? Thanks.

Arthur Yu, Chief Financial Officer

Okay. Tracy, if you can take the first one, then I will take the second one.

Tracy Li, Vice President of Strategic Business Development

Sure. No problem. Hello, thanks for the question. I think in terms of the consumer segment, both domestic and international brands face significant challenges. They both must address short-term problems while investing to win in the long run. In the online segment, most players are still emphasizing the importance of online performance due to relatively weaker in-store performance in recent quarters. Right now, we are working with our brand partners to devise a three-year plan focusing on direct consumer connection and smart budget allocation across channels. Regarding local brands, we are identifying collaboration opportunities in areas like IT services, content marketing, interactive marketing technology, and customer service.

Arthur Yu, Chief Financial Officer

As for our cooperation with Cainiao, we have continued to make good progress in terms of synergies. The synergies arise from three main areas. First, joint business development within the Cainiao and Alibaba ecosystems, which opens new business opportunities for both Baozun logistics and the broader Baozun service. Second, we benefit from the scale and structure provided by Cainiao, particularly in warehousing and last-mile delivery. Third, we see technology enhancement benefits, as previously we invested in logistics technologies, and now we can leverage Cainiao’s resources to implement technologies like RFID, resulting in improved efficiency in our operations. Overall, we view our alliance with Cainiao positively. For our Southeast Asia expansion, we are concentrating on building our capabilities in that region while replicating best practices from our operations in China. We aim to work closely with brands to enhance their e-commerce offerings in Southeast Asia. We will continue to report back to the market as we make further progress.

Thomas Chong, Analyst

Okay. Thank you.

Operator, Operator

Thank you. We will take our next question. Our next question comes from the line of Wang Zhihao from CICC. Please go ahead. Your line is open.

Wang Zhihao, Analyst

Hi. Good evening management. Thank you for taking my question. We noticed that the number of brand partners for store operations increased. As the macro environment is weak, could you please share your customer acquisition strategy used this quarter? Additionally, could you share some details about the new brand partners, such as their industries, scale, and the main channels through which we help them operate? Thank you.

Vincent Qiu, Chairman and Chief Executive Officer

Okay. Thank you. Tracy, would you like to take this? I can add more context after you.

Tracy Li, Vice President of Strategic Business Development

Sure. Thanks for the question. Last quarter, most of our new clients focused on our new revenue sources, specifically IT clients and digital marketing clients. They come from emerging categories like CUC and luxury. This indicates that our one-stop solution strategy, which initially focused on operations, is working as we expand our services into different areas. We are seeing clients invest significantly in their long-term strategies through interactive marketing and data infrastructure setups.

Arthur Yu, Chief Financial Officer

In addition, through our value-added services, we are leveraging the omni-channel strategy we have developed over time, which will also bring new business opportunities in the coming quarters. Thank you.

Wang Zhihao, Analyst

Thank you.

Operator, Operator

The next question comes from an analyst at Guangfa Securities. Please proceed; your line is open.

Unidentified Analyst, Analyst

Hello, management team. I have two questions. The first one is about the luxury revenue, which has seen strong growth in the past quarter. Could you elaborate on your future strategies for expanding the luxury category? Do you have a benchmark percentage for luxury revenue contribution? My second question is about your investment strategy for 2023. Thank you.

Arthur Yu, Chief Financial Officer

Okay. Let me answer your second question first, and then Tracy can cover the luxury question. Yes. In terms of investment strategy, we recently announced the acquisition of Gap China. In the short-term, our main focus will be on building the Gap business in China and developing our new Baozun brand management business unit. Our efforts will center around integration and transition to ensure success. In terms of investment, we will prioritize brand-related investments. I previously mentioned that Baozun has invested in six brands, either through minority or controlling stakes, and we’ve seen excellent growth. For example, the GMV from these brands during Double 11 has grown over 200% year-over-year, reflecting Baozun's value addition to these brands. Double 11 performance was also strong, with GMV growth of 22% year-over-year for Gap, surpassing market performance. As we look ahead, we will remain vigilant about good value assets, as we did with the Gap acquisition, while optimizing our investment portfolio.

Tracy Li, Vice President of Strategic Business Development

On luxury, we need to view the industry from multiple perspectives. In the short term, the market continues to face growth pressures, as evidenced in Double 11 where many brands have intensified their sales efforts, employing deeper discounts and promotional strategies. However, we see numerous brand partners committing to long-term investments in product innovation and consumer-centric strategies, increasing their budgets for content marketing and data infrastructure. This includes innovations such as extensive live-streaming efforts and limited edition product launches. For Baozun, luxury remains a strategic part of our business as this market continues to grow with low penetration. We see ongoing and future opportunities, supported by over a decade of experience in the fashion industry, which positions us well to grow with the luxury market over the next few years.

Operator, Operator

Thank you. We will take our next question. Our next question comes from the line of Charlie Chen from China Renaissance. Please go ahead. Your line is open.

Charlie Chen, Analyst

Thanks, management for taking my questions again. I have one question regarding the launch of BOCDOP. Can you provide more details on this topic? How do you perceive its cost and top-line contribution for 2023?

Vincent Qiu, Chairman and Chief Executive Officer

Thank you for the question. This is Vincent. I will elaborate on the concept behind BOCDOP. In Chinese, we have given it an institutional name to denote its product line or solution. Arthur, please share your views on revenue expectations.

Arthur Yu, Chief Financial Officer

Yes. Over the past several years, Baozun has developed what we call a middle-end system that includes all order fulfillment and processing systems. This Digital Operating Platform (DOP) plays a crucial role in supporting omni-channel retail and D2C-based business strategies. Traditional ERPs lack the necessary functionality for this rapidly evolving market in China, where omni-channel and online/offline integrations far surpass other regions. There’s a strong local demand for this type of system. This allows brands to operate their retail and D2C business across various channels seamlessly. Previously, we offered the highly customized approach; however, we have now packaged it into a more market-ready solution. We are actively marketing this solution to existing and prospective clients of various sizes to help implement their omni-channel strategies.

Vincent Qiu, Chairman and Chief Executive Officer

Additionally, beyond supporting clients with omni-channel order processing and fulfillment capabilities, we can deliver much better business intelligence and decision support capabilities based on data collected across channels. Yes.

Arthur Yu, Chief Financial Officer

Moreover, our continued investments in technology will not only benefit our traditional e-commerce businesses but also drive the transformation of the Baozun Brand Management business as well. This will create additional value moving forward.

Charlie Chen, Analyst

Thank you very much.

Operator, Operator

Thank you. There are no further questions. I would like to hand back to management for closing remarks.

Wendy Sun, Senior Director of Corporate Development and Investor Relations

Thank you, operator. In closing, on behalf of Baozun’s management team, we would like to thank you for your participation in today’s call. If you require any further information, feel free to reach out to the IR team. Thank you for joining us today. This concludes the call.

Operator, Operator

This concludes today’s conference call. Thank you for participating. You may now disconnect.