Earnings Call Transcript - VIPS Q2 2022

Operator, Operator

Ladies and gentlemen, good day, everyone, and welcome to Vipshop Holdings Limited Second Quarter 2022 Earnings Conference Call. At this time, I would like to turn the call to Ms. Jessie Zheng, Vipshop's Head of Investor Relations. Please proceed.

Jessie Zheng, Head of Investor Relations

Thank you, operator. Hello, everyone. Thank you for joining Vipshop's second quarter 2022 earnings conference call. With us today are Eric Shen, our Co-Founder, Chairman and CEO; and David Cui, our CFO. Before we begin, I would like to remind you that the discussion today will contain forward-looking statements made under safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. Potential risks and uncertainties include, but are not limited to, those outlined in our safe harbor statements in our earnings release and public filings with the Securities and Exchange Commission, which also applies to this call to the extent any forward-looking statements may be made. Please note that certain financial measures used on this call, such as non-GAAP operating income, non-GAAP net income, and non-GAAP net income per ADS are not presented in accordance with U.S. GAAP, please refer to our earnings release for the reconciliation of our non-GAAP measures to GAAP measures. With that, I would now like to turn the call over to Mr. Eric Shen.

Eric Shen, Co-Founder, Chairman and CEO

Good morning, and good evening, everyone. Welcome, and thank you for joining our second quarter 2022 earnings conference call. Our second quarter results came in better than expected driven by improving macro conditions towards the end of the quarter with the COVID-19 pandemic effectively under control. Supply chain and logistics efficiency largely recovered and the consumer segment gradually picked up. Our top line performance was aided by a month-on-month recovery in consumption, especially more resilient trends in June. Even though sales were still under pressure, our bottom line increased, and margins improved year-over-year thanks to greater operational discipline. This sector results demonstrate the resilience of our business model as well as the strong execution and flexibility of the entire company to address external uncertainties. Notably, we are doing a good job supporting the core brands that resonate with the values of our consumers. This has translated into strong brand partnerships and improved customer loyalty. During the quarter, core brands continued to outperform in sales momentum. Our buying team worked more closely than ever to engage with brand partners. We assisted them in navigating through an uncertain environment with extensive support from customer engagement, category planning to marketing campaigns. Brand partners were pleased to use our merchant platform with new features to manage and grow their business. In turn, we secured more supply of unique and quality products at competitive prices. In addition, we have been consistently refreshing our brand mix. We added more new trendy and high-end brands in both apparel and non-apparel categories targeting different customer groups. Accordingly, we rolled out several new channels such as Little Pink Box, VIP Trends, and VIP Luxury to support the growth of these new brands while creating new shopping experiences for our customers. In the second quarter, we successfully converted more high-value customers into paid members. Active Super VIP customers grew by 21% year-over-year and contributed 38% of online net GMV. They once again demonstrated their superior value with stable repeat purchases despite some cautious segments. With the future recovery highly dependent on macro developments, we are strategically anchored in discount retail for the long term. We are convinced that consumers always desire great brands, great selection at great value, especially as they become more rational in their spending today. We will continue to enhance our value proposition, adapting our business as needed to best serve our brand partners and customers. At this point, let me hand over the call to our CFO, David Cui, who will go over our financial results.

David Cui, CFO

Thanks, Eric, and hello, everyone. During the second quarter, we delivered solid profitability on decent top-line performance that beat our prior guidance. Our initiative to focus on core brands has been working well, and our gross margin increased to 20.5% from 20.1% a year ago. This was achieved as we identified many opportunities to streamline the cost structure in both apparel and non-apparel categories and managed to improve category gross margins effectively. We also made less effort to drive operational efficiency. Notably, we continue to see some leverage from marketing as we became more rational in spending regarding acquiring and retaining customers. As a result, our non-GAAP net income increased year-over-year to RMB 1.6 billion, and the non-GAAP net margin expanded by 1.5% to 6.5%. Additionally, we remain committed to our USD 1 billion share buyback program announced in March. We have repurchased $177.1 million of our ADS during the second quarter. Looking ahead, we'll remain focused on our merchandising strategy and looking for ways to operate our business more efficiently. Maintaining healthy and sustainable profitability continues to be our near-term financial priority in an uncertain environment. Now moving to our detailed quarterly financial highlights. Before I get started, I would like to clarify that all financial numbers presented below are in renminbi, and all percentage changes are year-over-year changes unless otherwise noted. Total net revenues for the second quarter of 2022 were RMB 24.5 billion compared with RMB 29.6 billion in the prior year period, primarily attributable to soft consumer demand for discretionary categories amid a changing macro environment with COVID-19 resurgence in China. Gross profit was RMB 5.0 billion compared with RMB 6.0 billion in the prior year period. Gross margin increased to 20.5% from 20.1% in the prior year period. Total operating expenses decreased by 18.7% year-over-year to RMB 3.9 billion from RMB 4.8 billion in the prior year period. As a percentage of total net revenues, total operating expenses decreased to 16.1% from 16.4% in the prior year period. Fulfillment expenses decreased by 13.7% year-over-year to RMB 1.8 billion from RMB 2.1 billion in the prior year period. As a percentage of total net revenues, fulfillment expenses was 7.2% compared to 6.9% in the prior year period. Marketing expenses decreased by 60.5% year-over-year to RMB 555.6 million from RMB 1.4 billion in the prior year period, primarily attributable to a more prudent marketing strategy. As a percentage of total net revenues, marketing expenses decreased to 2.3% from 4.8% in the prior year period. Technology and content expenses increased by 11.3% year-over-year to RMB 411.8 million from RMB 369.9 million in the prior year period. As a percentage of total net revenues, technology and content expenses increased to 1.7% from 1.2% in the prior year period. General and administrative expenses were RMB 1.2 billion compared with RMB 1.0 billion in the prior year period. As a percentage of total net revenues, general and administrative expenses were 4.9% compared with 3.4% in the prior year period. Income from operations was RMB 1.3 billion compared with RMB 1.5 billion in the prior year period. Operating margin increased to 5.2% from 5.0% in the prior year period. Non-GAAP income from operations was RMB 1.6 billion compared with RMB 1.7 billion in the prior year period. Non-GAAP operating margin increased to 6.3% from 5.9% in the prior year period. Net income attributable to Vipshop shareholders increased by 17.4% year-over-year to RMB 1.3 billion from RMB 1.1 billion in the prior year period. Net margin attributable to Vipshop shareholders increased to 5.2% from 3.7% in the prior year period. Net income attributable to Vipshop shareholders per diluted ADS increased to RMB 1.97 from RMB 1.56 in the prior year period. Non-GAAP net income attributable to Vipshop shareholders increased by 8.4% year-over-year to RMB 1.6 billion from RMB 1.5 billion in the prior year period. Non-GAAP net margin attributable to Vipshop shareholders increased to 6.5% from 5.0% in the prior year period. Non-GAAP net income attributable to Vipshop shareholders per diluted ADS increased to RMB 2.45 from RMB 2.10 in the prior year period. Looking forward to the third quarter of 2022, we expect our total net revenues to be between RMB 21.2 billion and RMB 22.4 billion, representing a year-over-year decrease of approximately 10% to 15%. Please note that this forecast reflects our current and preliminary view of the market and operational conditions, which are subject to change. With that, I would now like to open the call to Q&A.

Operator, Operator

Our first question comes from Thomas Chong of Jefferies.

Thomas Chong, Analyst

Congratulations on a very solid set of results, with top and bottom line exceeding market expectations. When we come into the second half, given the global macro headwinds that we are facing right now, how should we think about the second half outlook, as well as the recovery momentum in July and August? And my second question is relating to competition. How should we think about the competitive threat from live streaming, online shopping and short-form video sites?

Eric Shen, Co-Founder, Chairman and CEO

Congratulations on a strong set of results, with both revenue and profits surpassing market expectations. As we look toward the second half, considering the global macro challenges we are currently facing, what is your outlook for that period and the recovery trend in July and August? Additionally, how should we assess the competitive threat posed by live streaming, online shopping, and short-form video platforms?

Jessie Zheng, Head of Investor Relations

Okay, so turning to your first question. Understandably, we have seen from March to May, the whole e-commerce sector has been very hard hit by COVID-19. But we have seen that the year-over-year trend has been improving into June and also July and August. We had a better June promotion than expected and sales in July continued to show some slight month-on-month recovery. In August, that momentum continued. But on the other hand, there is still some uncertainty regarding the recovery momentum. It's highly dependent on macro developments, especially as well as the weather conditions. Actually, the e-commerce industry is very sensitive to the weather conditions, particularly as we are apparel-focused; unfavorable weather may delay the demand for autumn and winter clothing. And also, with the new COVID flare-ups, consumers remain cautious about spending and the overall macro backdrop is not comparable to what we saw last year. So there is still some uncertainty ahead. Turning to your second question on competition from live streaming: there is no big change in the competitive landscape, and we think competition is actually leveling off. Live streaming has been around for over two years and they are doing fine, especially in standardized items, where they perform much better than apparel categories. However, we are more specialized in apparel categories, which is still a very sophisticated segment and difficult for live streaming platforms to absorb all the market share. We have been monitoring data from the live streaming platforms, and we think their traffic and business momentum have been relatively stable.

Operator, Operator

We will now take the next question from Ashley Xu of Credit Suisse.

Ashley Xu, Analyst

My first question is about our SVIP strategy. We've noticed positive growth even during the emergence of COVID. Can you clarify what is driving this growth? My second question pertains to the recent cold weather and its impact on our strategy, including consumer behavior and merchandising.

Eric Shen, Co-Founder, Chairman and CEO

My first question is about our SVIP strategy. We have seen that the growth has been quite good even during the emergence of COVID. I would like to know what the key driver of this growth is. Additionally, my second question concerns the recent cold weather's impact on our strategy, particularly regarding consumer behavior and merchandising.

Jessie Zheng, Head of Investor Relations

Okay. On the first question related to SVIP, we have been focusing on growing our SVIP customers for several quarters. They now contribute around 38% of our online net GMV, and we expect this contribution to increase in the coming quarters. We have several SVIP membership privileges to offer to incentivize high-value customers into SVIPs. For example, we have extra 5% benefits, Super VIP sales day on the 28th of each month, and Super VIP membership stores. We are increasingly focused on creating different shopping experiences for them, offering best sellers and brands on a time-limited basis so that they feel they are constantly seeking out values on our platform. We have a variety of cross-platform programs to incentivize more high-value customers into SVIPs. We are confident that SVIPs in terms of their customer base and ARPU and GMV contribution will grow going forward. On the second question related to our merchandising strategy in response to the recent cold weather conditions, we have plenty of time from our brand partners for autumn and winter clothing. For example, by the end of August, we plan to launch our campaign for autumn apparel, provided the weather conditions are favorable. We don't have issues with product supply availability from our brand partners because we have been highly engaged with them as to how we should prepare for the coming seasons. For instance, we have been working with down jacket brands for winter clothing to stock as many SKUs as possible in case the weather gets colder sooner than expected. So that's how we work with our brand partners. We don't currently have a problem with inventory from our brand partners.

Operator, Operator

Next question will come from the line of Alicia Yap from Citi.

Alicia Yap, Analyst

Congrats on the strong results. I have two questions. First, your Q3 guidance appears a bit conservative given your achievements in the second quarter, and it seems you've experienced improving trends in July and August. My second question is regarding margin. This quarter, the margin saw significant improvement. Is there potential for further enhancement, or will the level from the second quarter establish a new baseline for future quarters?

Eric Shen, Co-Founder, Chairman and CEO

Congrats on the strong results. I have two questions. The first one is that it seems like your Q3 guidance is a bit conservative considering what you've achieved in your second quarter. Also, it seems you've been seeing improving trends in July and August. My second question is on margin. This quarter, the margin actually improved quite a lot. Is there any further room for improvement, or will the second quarter level set a new base for future quarters?

Jessie Zheng, Head of Investor Relations

Our Q3 guidance of a negative 10% to 15% actually takes into account several factors. For example, we expect there to be fluctuations in COVID-19 cases and that it will take time for consumer confidence to gradually recover. Lastly, we are unsure about the weather conditions in July and whether it will be cold enough for us to launch the autumn marketing campaign. Therefore, we prefer to be slightly conservative, but we will do our best to achieve strong top-line performance. Regarding margins, I'll start with a few points, and David will add additional details later. We did scale back some of our marketing expenses in the second quarter, which resulted in good profitability. For the long term, our goal for the coming quarters is still to bring customers back to a positive growth trajectory. We will spend as needed and seize opportunities whenever we can to acquire customers. However, we will continue to act rationally. At the same time, we are confident that we can maintain healthy and sustainable profitability because we have been effective at managing costs and expenses. We have a proven track record in providing financial stability. David?

David Cui, CFO

Yes, in the first half of this year, we have focused on improving our operational efficiencies. We have been very disciplined in our spending. Our goal for the second half remains to maintain quality business scale. While improving operational efficiencies, we must balance profitability and growth; we will potentially look for opportunities to acquire new customers. This means we could increase our marketing expenditures, but we must be disciplined in that initiative. Having said all this, we are confident that our profitability and net margin will at least remain stable for the second half.

Operator, Operator

Our next question comes from the line of Tian Hou of TH Capital.

Tian Hou, Analyst

So regarding the inventory buildup overseas and in China, we noticed a decline in orders. It appears that inventory levels and manufacturing are increasing. Historically, Vipshop has been effective at assisting manufacturers in reducing their inventory. Could you clarify how Vipshop intends to take advantage of these opportunities in the second half?

Eric Shen, Co-Founder, Chairman and CEO

So related to the inventory buildup overseas and also in China, we saw the orders declined. It seems like the inventory numbers and manufacturing are building up. In the past, Vipshop has been very good at helping manufacturers reduce inventory. Could you provide Mr. Shen some clarity on how Vipshop plans to capture such opportunities in the second half?

Jessie Zheng, Head of Investor Relations

Okay. Let me share a few of my observations here. First, we work with many primary domestic brands as well as some international brands. However, that's not quite relevant to the export environment, as they rely on imports, and we've seen some productions ramping up in the recent months. Second, regarding inventory, there are a few factors at play today. Firstly, due to COVID-19, many offline stores are struggling, resulting in inventory build-up. Secondly, due to recent lockdowns, some brands scaled back on their production. Fortunately, things are improving now, and brands are beginning to increase their orders again. Generally speaking, we potentially stand to benefit from a favorable inventory cycle because we see excess inventories now, which actually exceed last year's levels. Along with securing unique and quality supply from our brand partners, we also have the Made-for-Vipshop line, which is quite stable and serves as a long-term channel for us. We believe we don't have issues regarding inventory availability and we can secure the best supply from our brand partners.

Operator, Operator

Our next question comes from Eddy Wang of Hangen Stanley.

Eddy Wang, Analyst

My first question is about your revenue growth. When should we expect our revenue growth to return to positive territory in the upcoming quarters? The second question is whether this growth will mainly be driven by an increase in users as revenue moves back into positive territory?

Eric Shen, Co-Founder, Chairman and CEO

My first question is about your revenue growth. When should we expect our revenue growth to return to positive territory in the following quarters? The second question is whether it will be primarily driven by user growth as revenue growth moves back into positive territory?

Jessie Zheng, Head of Investor Relations

Yes, regarding whether our GMV and revenue growth will be driven by customer growth in the coming quarters, our goal is to bring our customer base to positive growth starting from the third quarter because we saw a significant decline in customer activity in the second quarter. This decline was primarily due to COVID's impact, which limited people's ability to shop more freely. For example, last year, there were 100 shoppers on our platform, but in the second quarter of this year, that figure dropped to 83. As this metric is on a rolling basis, entering the third quarter, we may face pressure on our customer base. That’s why we will invest as necessary to bring our customer numbers back into positive growth this quarter.

Operator, Operator

We'll now take the next question from Wei Xiong of UBS.

Wei Xiong, Analyst

I have two follow-up questions. First, we discussed the goal of returning to positive user growth starting in the third quarter. I would like to know more about the marketing strategy, user acquisition strategy, and marketing expense plan related to this goal. My second question is about the Q3 guidance being more cautious due to macroeconomic uncertainty. Do we anticipate a greater chance of a strong rebound in Q4 due to year-end promotions and the low base from last year?

Eric Shen, Co-Founder, Chairman and CEO

I have two follow-up questions. First, we just talked about wanting to see user growth returning to positive territory starting in the third quarter. I want to ask about the marketing strategy, user acquisition strategy, and marketing expense plan around this goal. My second question relates to the Q3 guidance being more conservative due to macro uncertainty. Do we see a higher chance of a strong rebound in Q4 given the year-end promotions as well as the low base from last year?

Jessie Zheng, Head of Investor Relations

In terms of our customer acquisition strategy, we plan to increase spending on acquiring new customers starting in the third quarter. In the past few quarters, due to COVID restrictions, we somewhat paused our new customer acquisition efforts in certain regions. We are now trying to recommence our investments in acquiring customers in those areas. Our strategy continues to focus on App Store pre-installations and targeted marketing for new customers. Meanwhile, we aim to reactivate customers who previously shopped with us. We are utilizing targeted marketing to bring back some of the 17% of customers who previously used our platform but couldn't do so due to COVID restrictions. Regarding the Q4 outlook, we are optimistic that if we can shift our customer acquisition back onto a growth trajectory in Q3, we can expect positive developments in Q4, given that it's our peak season. In previous quarters, we've capitalized on economic downturns to optimize our merchandising portfolio and bolster the customer mindshare for discount retail among our customers. Therefore, we are optimistic about an upside in Q4 if conditions remain favorable.

David Cui, CFO

Yes, I’d like to add something here. When implementing all these marketing initiatives in the third quarter and the following quarter, we will not sacrifice our profitability. We will be cautious when launching these programs and aim to do a significantly better job than we have in the past to ensure a strong return on investment from all of these initiatives.

Operator, Operator

We have our next question from Andre Chang from JPMorgan.

Andre Chang, Analyst

Let me translate my two questions. The first question is about the seasonal impact on gross margin and product mix. Historically, the second quarter is peak season for apparel sales, which leads to higher gross margins. But this year, is there any change in the mix? Does that mean the gross margin seasonal decline into the third quarter will be milder than usual? My second question is related to CapEx, which seems to have doubled in the second quarter. What is the driver behind this, and will we continue to invest at this pace in the current macro environment?

Eric Shen, Co-Founder, Chairman and CEO

Historically, the second quarter is peak season for apparel sales, resulting in higher gross margins. This year, is there any change in the product mix? Does this indicate that the decline in gross margin into the third quarter will be less severe than usual? My second question concerns capital expenditures, which appear to have doubled in the second quarter. What is causing this increase, and will we maintain this level of investment given the current macro environment?

Jessie Zheng, Head of Investor Relations

On the gross margin, we believe seasonality does not impact our gross margin significantly. In the second quarter, the gross margin tends to be lower due to promotions and weak apparel demand. In the third quarter, there are fewer promotions, although we might sell less apparel. I want to clarify that we have taken numerous cost-saving initiatives this year to stabilize and improve our gross margin, such as ceasing delivering coupons at the cost of our own profits, being prudent with issuing additional coupons, and stopping spending on channels that weren't economically beneficial. Additionally, we’ve implemented measures to optimize the cost structure and improve gross margin processes. For instance, we're handling customer returns more effectively without compromising on our benefits. These initiatives have proven effective, and we are confident in maintaining relatively stable gross margins going forward.

David Cui, CFO

The capital expenditure for the quarter is largely for the Shenzhen outlet. We plan to add three new outlets this year, and many of the payments for land use rights are upfront, so cash outflow does not necessarily align with the opening of the outlets. However, comparing the capital expenditure for the Shenzhen outlets year-over-year should be fairly consistent. This particular quarter may appear higher, but throughout the year, it should normalize.

Operator, Operator

Our next question comes from Natalie Wu of Haitong International.

Natalie Wu, Analyst

Let me quickly translate my questions. First, I would like to clarify if the positive user growth mentioned refers to the year-on-year increase in active customers for the third quarter. If so, that amounts to 2.2 million active users, which could lead to an increase of RMB 200 million to RMB 400 million in sales and marketing expenses if the cost of acquiring users stays the same. I'm interested in how this aligns with the previously discussed stable margin profile. My second question concerns bargaining power. In light of the current situation where suppliers impacted by COVID are experiencing tighter inventory issues, does this give you more leverage to secure better offers?

Eric Shen, Co-Founder, Chairman and CEO

Yes, that translates to 2.2 million active users. If the cost of acquiring new users stays the same, that results in an increase of RMB 200 million to RMB 400 million in additional sales and marketing costs. I'm interested in how this fits with the stable margin profile mentioned earlier. My second question relates to bargaining power. Considering the current circumstances where suppliers impacted by COVID are experiencing heightened inventory challenges, does this strengthen your bargaining power to obtain better deals?

Jessie Zheng, Head of Investor Relations

First, regarding customer acquisition cost, it isn’t a single mass. It doesn’t mean that adding 2 million customers would require us to spend RMB 200 to RMB 400 million every quarter; we may have to spend a bit more on acquiring new customers. However, reactivating old customers, particularly those who were active last quarter, is not that expensive and is significantly less than RMB 100 per customer. Therefore, we can assure you that our marketing spend as a percentage of total revenue will not exceed what we've seen during the same period last year. We aim to leverage a combination of great brands, great selection, great prices, and better personalized recommendations to achieve our goal of positive customer growth. Secondly, regarding inventory, we have adequate inventory as I have mentioned earlier. We work closely with our brand partners to secure unique and quality products, most of which are still on a consignment model. If we were purchasing supplies outright, we might have stronger bargaining power. However, since it is a consignment model, we are not required to increase the percentage we take from the brands; it remains within a normal range. We also wish to continue supporting the core brands. We may even lower our take rate slightly to ensure they can grow faster on our platform with a stronger supply of quality product offerings. The core brands can deliver real value to our customers and enhance consumer mind share for Vipshop as a discount platform. This is how we collaborate with our brand suppliers; we aim to support them and create a win-win situation for both parties.

David Cui, CFO

To clarify your first question regarding customer acquisition, a large portion of new customer additions should come from reactivating existing registered active customers. The cost to reactivate these customers is relatively small.

Operator, Operator

Thank you, management. Due to the time constraints, that concludes today's question-and-answer session. At this time, I will turn the conference back to Ms. Jessie Zheng for our closing remarks.

Jessie Zheng, Head of Investor Relations

Thank you for taking the time to join us today. If you have any questions or follow-ups, please don't hesitate to contact us. We look forward to speaking with you next quarter.