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Edited Transcript of ZTO.N earnings conference call or presentation 16-Aug-19 1:00am GMT

Q2 2019 ZTO Express (Cayman) Inc Earnings Call

SHANGHAI Aug 16, 2019 (Thomson StreetEvents) -- Edited Transcript of ZTO Express (Cayman) Inc earnings conference call or presentation Friday, August 16, 2019 at 1:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Huiping Yan

ZTO Express (Cayman) Inc. - CFO

* Meisong Lai

ZTO Express (Cayman) Inc. - Founder, Chairman & CEO

* Sophie Li

ZTO Express (Cayman) Inc. - IR Director

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Conference Call Participants

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* Baoying Zhai

Citigroup Inc, Research Division - VP & Head of the Hong Kong and China Transport

* Cherry Leung

Sanford C. Bernstein & Co., LLC., Research Division - Research Analyst

* Jialong Shi

Nomura Securities Co. Ltd., Research Division - Head of China Internet & Media Research and VP

* Melissa Chen

China Renaissance Securities (US) Inc., Research Division - Analyst

* Parash Jain

HSBC, Research Division - Head of Transport Research, Asia-Pacific

* Ronald Keung

Goldman Sachs Group Inc., Research Division - Executive Director

* Tianxiao Hou

T.H. Capital, LLC - Founder, CEO & Senior Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to the ZTO Express Announcement of the Second Quarter Financial Results on August 15, 2019. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Sophie Li, IR Director. Please go ahead.

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Sophie Li, ZTO Express (Cayman) Inc. - IR Director [2]

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Thank you, operator. Hello, everyone, and thank you for joining us today. The company's results and the Investor Relations presentation were released earlier today and available on the company's IR website at ir.zto.com.

On the call today from ZTO are Mr. Meisong Lai, Chairman and Chief Executive Officer; and Ms. Huiping Yan, Chief Financial Officer. Mr. Lai will give a brief overview of the company's business operations and highlights, followed by Ms. Yan who will go through the financials and guidance. They will both be available to answer your questions during the Q&A session that follows.

I remind you that this call may contain forward-looking statements made under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements are based on management's current expectations and current market and operating conditions and relate to events that involve known or unknown risks, uncertainties and other sectors, 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, performance or achievements to differ materially from those in the forward-looking statements. Further information regarding this and other risks, uncertainties and factors is included in the company's filings with the U.S. Securities and Exchange Commission. The company does not undertake any obligation to update any forward-looking statements as a result of new information, future events or otherwise except as required under law.

It is now my pleasure to introduce Mr. Meisong Lai. Mr. Lai will read through his prepared remarks in their entirety in Chinese before I translate for him in English. Lai Song?

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Meisong Lai, ZTO Express (Cayman) Inc. - Founder, Chairman & CEO [3]

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(foreign language)

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Sophie Li, ZTO Express (Cayman) Inc. - IR Director [4]

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Okay. First, please let me translate for Chairman.

[Interpreted] Hello, everyone. Thank you for joining us [on today's] call to discuss the company's second quarter results.

During the quarter, ZTO maintained industry-leading service quality and customer satisfaction and delivered 3.11 billion packages, an increase of 46.8% year-over-year or 18.5 percentage points higher than the industry average. The company's market share rose 2.5 percentage points to 19.9%.

Meanwhile, the adjusted net income grew 25.6% to CNY 1.38 billion. ZTO has been consistent, we've been successfully executing our core strategy. That is we will continuously to extend our market share based on high quality of service and targeted level of profit. At the beginning of 2019, we accelerated volume growth rate to 15 percentage points faster than the industry average from the previous 10 percentage points. ZTO's second quarter results reflected the soundness of our strategy and our ability to effectively execute.

Network-wide volume incentive metrics we introduced in the first quarter continue to take positive impact in driving volume growth in the second quarter. With fairness and transparency, we enhance our legacy programs and since we've had many individualized arrangements. As a result, volume incentives are optimized, and the network is better equipped to address the intensifying competition.

As one of the measures to further implement standardized pickup and delivery fee schedules across the network, ZTO enhanced the cooperation and rebalanced the equity amongst major pickup regions and their corresponding delivery regions so as to ensure stability and long-term sustainability of the network. Even as volume grow significantly, ZTO maintained leadership position in service quality and customer satisfaction. In addition, we continue to achieve cost productivity. Through scale advantage and technology, we were able to better leverage our infrastructure capacity and manage incremental costs in support of high-volume growth. Combined sorting hub and line-haul transportation costs per parcel declined 8.6%, partially offsetting competition-led subsidy increases. Consequently, ZTO achieved its target and delivered operating profit growth in the second quarter.

China's express delivery industry benefited quickly from the rapid growth of the country's e-commerce-driven consumer economy. New business models for consumption, sales and distribution and logistics continue to rise and quickly evolve. Together with added attention from strategic and financial investments, that become more evolved. China's express delivery businesses are facing new commercial demands and the new challenges from changing industry dynamics.

To maintain competitive edge, ZTO must achieve strengthening of our core competencies as well as building a wider moat to sustain our future growth. First of all, we must strive to be the best at what's within our control. For example, stricter implementation of new strategies across networks with steeper and wider proliferation; regional-level KPI metrics with was proven design and constant enhancement cycle; synergistic integration and the collaborative use of platform resources; and accelerated establishment of data-driven and value-add operational management framework, to name just a few.

Secondly, when you do things ahead about how to leverage ZTO's advantages in scale, network coverage and financial resources to seize market opportunities and wider competitive lead, on one hand, we intend to thoroughly implement our standardized pickup and delivery fee schedules across our network. It will allow ZTO frontline couriers to achieve the high-risk income among their peers, thus, becomes sales motivated to bring more business with operations improved service quality and customer loyalty. On the other hand, we will resource plan for last mile to build low-cost and value-added capabilities so as to support frontline competitive strengths and the stability of our entire network.

In addition, we will actively explore new ways to enhance our value proposition in comprehensive logistics and supply chain management services to better serve new commercial needs. By maximizing the value and the capabilities, including talent and the capital resources we have assembled on our platform, we are able to establish systematic competitive advantage that are less dependent on online or offline traditional retail and commerce.

China's express delivery market has great potential for expansion. We believe it is likely to maintain steady growth in the near term. Everyone under the ZTO brand is proud of our first half of 2019 performances, and we are energized to work harder and to continue charge ahead. We firmly believe that we can ensure our long-term success by knowing and leveraging our existing strengths, working smarter, making transformations and embracing the future. Thank you for your attention.

Next, let us here from Ms. Yan who will discuss our financials.

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Huiping Yan, ZTO Express (Cayman) Inc. - CFO [5]

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Thank you, Chaiman Lai, and hello to everyone on the call. As I go through our financial results, please note that unless specifically noted, all numbers quoted are in RMB, and percentages changes refer to year-over-year comparison. Detailed analysis of our financial performance, unit economics and cash flow details are posted on our website, and I will highlight some of the key points below.

Our parcel volume grew 18.8 percentage points faster than the industry average, and our market share was 19.9% for the quarter. And we exceeded market expectations on adjusted net income in spite of more parcel price decline than previously anticipated. Total revenue for our core express business grew 30.2%. The 33.4% cost of goods sold increase against a 46.8% parcel volume growth indicated healthy scale leverage and effective cost management at ZTO. Gross profit grew 21.4%, and income from operations grew 25.6% as we maintained a stable and efficient corporate structure where SG&A excluding SBC as a percentage of revenue decreased to 5.4%, comparing that of 5.7% last year. Income from operations excluding SBC grew 23.6%, and op margin rate decreased 1.3 percentage points as a result of volume increase. Cost incentive increased only fully -- and the cost productivity gain only absorbed partial of the impact of incentive cost increase.

GAAP-basis income variances reflected a onetime disposal gain in second quarter of 2018 in the amount of CNY 225 million. Taking into that consideration, net income increased 27.9%. And if we further take -- if we further exclude SBC, adjusted net income grew 25.6% to reach CNY 1.38 billion, and adjusted net income margin rate declined slightly by 0.7 percentage points to 25.4%. One additional note on key accounts. Revenues from key accounts were approximately CNY 650 million, which grew 60.2% and accounted for around 12% of our total revenue.

Now turning to per-parcel unit economics. ASP decline was CNY 0.21, out of which CNY 0.20 was associated with volume incentives. Price competition intensified especially in the month of June, and we responded accordingly. Cost of goods sold went down by 9% -- CNY 0.09 per parcel, of which the increased use of self-owned vehicles with increasing proportion of high-capacity trailer trucks helped drive down transportation costs by CNY 0.06 per parcel. And the increase in the number of automated sorting equipment helped keeping the number of head count increases to only 18.6% and contributed CNY 0.06 -- CNY 0.02 reduction in sorting hub costs per parcel. With better SG&A leverage, we are able to claw back another CNY 0.02, hence, the adjusted operating income per parcel declined CNY 0.09.

Operating cash flow was CNY 1.99 billion, and CapEx spending was CNY 812 million, which brings year-to-date total CapEx spending to CNY 1.7 billion. Our annual CapEx commitment remains CNY 6 billion to CNY 8 billion as we expect cash outlay to be around CNY 4 billion to CNY 6 billion for the year.

The company maintains its annual forecast and guidance given the market consider -- given the market condition and also our operational capabilities. This concludes our prepared remarks, and we will now open the lines for questions. (Operator Instructions)

Isabella, please open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question today comes from Baoying Zhai with Citi.

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Baoying Zhai, Citigroup Inc, Research Division - VP & Head of the Hong Kong and China Transport [2]

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(foreign language) So I translate my questions first. So congratulations for the great results. I have 2 questions. First of all, I want to ask Mr. Lai about the future competition landscape and the pricing strategy. So far, our pricing strategy is very successful this year. We have strong market share gaining and also see the competitors earnings and their franchisees are under huge pressure. Looking forward, do we still want to continue this pricing? Recently, we are seeing some release of pricing competition in Yiwu.

Second question is regarding the full year guidance. So far, we still remain the full year guidance. But given the strong performance of first half, this sounds a little bit conservative. What's the reason behind?

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Meisong Lai, ZTO Express (Cayman) Inc. - Founder, Chairman & CEO [3]

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(foreign language)

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Sophie Li, ZTO Express (Cayman) Inc. - IR Director [4]

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First, let me translate for Chairman.

[Interpreted] The competition in the marketplace has been intensifying in the second quarter. And we look into the second half of the year, there are hopes perhaps the price could level up, and we are hoping for that. And regarding Yiwu, we consider the strategy to be our main focus, which is to maintain quality of services as we achieve targeted earnings, we will expand our market share consistently. The price practice at Yiwu has been deviating from the market economy and the nature of a business which we always believe that making money is important for us, effective parcel that are being brought in into the business could sustain our long-term growth. With that in mind, we hope that the second half of the year should see the price becomes more reasonable. And also for the longer term, we believe price stabilization and perhaps increase is inevitable.

Now Baoying, if I may answer the other question points that you have. Yes, you're right that we have been very effective in executing our strategy. Given the market environment and our ability to deliver consistently on our strategy, we believe being prudent has always been our approach. And certainly, we have high confidence in our ability to deliver on our overall growth target which is exceeding market average by at least 15 percentage points and increase our distance in terms of market share compared to our peers. Second half will continue to have such focus for us. And we don't believe changing the guidance will make any difference in terms of how we would execute on our overall strategy. We maintain our targeted profit, guidance and volume increases as well as price policies and price actions will all be dependent on the market. And we have the ability to adjust accordingly not only on the price side but also on our cost side, so we are confident.

Now one point to add regarding the franchisees and also our overall network, we are still at the stage of maintaining overall facility and profitability of our franchisees. The average size for ZTO's delivery fee is still higher. That indicates that we have not encroached upon our franchisees' profit. If it's necessary in the future where we all need to share greater burden, we will do so without hesitation.

And I hope this answers all your question points.

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Operator [5]

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Your next question comes from Ronald Keung with Goldman Sachs.

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Ronald Keung, Goldman Sachs Group Inc., Research Division - Executive Director [6]

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(foreign language) So 2 questions. Firstly is on the market structure. We're seeing that Yunda has been growing at a very fast pace. So it seems like the industry is heading towards 2 big mega players and number 3, 4, 5 in sort of the second layer that is more subscale versus #1 and #2. So I just want to hear what is our strategy particularly given a #2 player has been chasing us at a very fast pace, whether we want to expand our market share leadership to maintain as the one dominant leader in the space.

And my second question will be could you share some of the volume compositions across Alibaba and Pinduoduo. Just want to see how that volume progression has been from these 2 platforms, if you have the data.

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Meisong Lai, ZTO Express (Cayman) Inc. - Founder, Chairman & CEO [7]

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(foreign language)

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Sophie Li, ZTO Express (Cayman) Inc. - IR Director [8]

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[Interpreted] Thank you, Ronald, for your question. The first question, it's apparent that the China express delivery market has been going through further concentration, and the market share has been concentrating onto the scaled large players. Last year, we have set our goal to grow faster than the market in 10 percentage points. And this year, we raised that to 15 percentage points, and that is to further accelerate our growth to pull away from the rest, as you indicated. And it is advantage for ZTO to achieve this goal based on our scale, cost and also capital advantage. The toolbox is still full, using Chairman's term. We still have many tools or leverage that we can pull depending on the market conditions and also the competitive landscape changes. The expected range that we have landed with our performances is as we previously planned. Without significant changes, we will maintain our course, maintain our pace. And meanwhile, we will focus on the task at hand, one being raising our last-mile couriers' earnings to be the highest amongst the industry; and then two, accelerate our efforts in building our last-mile capabilities. And these are some of the key areas or initiatives that we will rely on to further pull away from the rest.

The second question relating to Pinduoduo and Alibaba's statistics, as of this quarter, Alibaba's volume represents 56% of our total, and Pinduoduo was 20%. And compared to last year, Alibaba was at 63%, and Pinduoduo was 13%. Sequentially, Pinduoduo increased by 2 percentage points, which is growing much faster, of course.

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Operator [9]

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Your next question comes from Melissa Chen with China Renaissance.

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Melissa Chen, China Renaissance Securities (US) Inc., Research Division - Analyst [10]

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(foreign language) I'll translate for myself. So the first question is still a follow-up on the industry landscape. So I'm just wondering, will we see some mergers among players in the sector? And the second question is on the cost savings. So we already see like 65% of our orders are already processed by the automation equipment, and 64% of our trucks are already self-owned, 15- to 17-meter trucks. So I'm wondering what's our cost-saving potential especially in the Q4 when we have the shopping carnivals such as Double 11 and Double 12.

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Meisong Lai, ZTO Express (Cayman) Inc. - Founder, Chairman & CEO [11]

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(foreign language)

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Sophie Li, ZTO Express (Cayman) Inc. - IR Director [12]

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[Interpreted] The Chairman indicated that for the first question, the overall trend for the industry is consolidation. As you can see from the past, the CR8 or [CR6] index has been consistently increasing. And even without M&A, there will be consolidation -- or there has been consolidation. And in addition, the first tier -- the scaled express businesses are also separating into different tiers: Tier 1, Tier 2, and perhaps there are Tier 3 in terms of their volumes and the distance between those tiers.

On the second question, we will be continuing our efforts in cost productivity going forward. The self-owned fleet as well as automation are 2 of the key areas that we are focusing on now, and there are still plenty of room for our investment and also our further productivity gain. For example, the smart machinery investment technology involved decision-making. For example, some of the larger sorting equipment have been put in place across our sorting hubs. The dynamic weighing machine will also help alleviate manual-driven and also labor-dependent activities in our production process. The key, though, however, in the competition or competitive advantage comes from the last mile or the 2 areas that we have discussed. One, ensure our pickup and delivery fee schedules have been fully implemented so that last-mile couriers will fully benefit from the pickup fee and the difference between the pickup fee and what they have to submit to the outlet. And that is what we are referring to, to have our couriers earn the highest in the marketplace in terms of their earnings. And then two, we are in the process and will continue to invest in the last mile. It not only helps provide individualized service to our consumers but also allow us to reduce cost. All those are what we have mentioned in early discussion. And also going forward, that will help us provide greater competitive advantage not only in the cost at the platform level but more so in the last mile.

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Operator [13]

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(Operator Instructions) Your next question comes from Tian Hou with T.H. Capital.

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Tianxiao Hou, T.H. Capital, LLC - Founder, CEO & Senior Analyst [14]

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(foreign language)

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Meisong Lai, ZTO Express (Cayman) Inc. - Founder, Chairman & CEO [15]

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(foreign language)

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Tianxiao Hou, T.H. Capital, LLC - Founder, CEO & Senior Analyst [16]

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I forgot what is the first question. Okay. (foreign language)

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Meisong Lai, ZTO Express (Cayman) Inc. - Founder, Chairman & CEO [17]

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(foreign language)

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Huiping Yan, ZTO Express (Cayman) Inc. - CFO [18]

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Okay, I'll translate for you first.

[Interpreted] The first question regarding that there are no problems, some of the statistics around our key account customers. And then the second question regarding some of the socio-micro merchants and what are our thoughts around those and how we are approaching that part of the opportunity, right?

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Tianxiao Hou, T.H. Capital, LLC - Founder, CEO & Senior Analyst [19]

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Yes.

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Huiping Yan, ZTO Express (Cayman) Inc. - CFO [20]

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So the first question, the revenues generated by our key accounts in this quarter was about CNY 650 million, and it accounts for about 12% of our revenue, and it's up about 60% from the same quarter last year. And in terms of volume, it represents about 7% or so of our total volume. It did increase about 96% from the same period last year.

If I may add at the key accounts, gross margin has increased slightly this quarter by about 50%. So if I may add a little background, the key accounts are some of those large businesses, for example, UNIQLO, Alipay and Ctrip. And they have a higher bargaining power, of course, and -- but they also have higher quality of service requirements. And those accounts are handled by headquarters instead of franchisees directly because the volume requirements and also quality of service requirements, that can only be better handled by -- across networks, so we are better at coordinating that.

The second question relating to the small micro businesses, that has always been part of our business, and we are finding ways to better serve them. One of our system that is called (foreign language) is directly addressing those needs, and the volume has been increasing in the previous quarters consistently. So what you have observed is correct that there is a rise in this area.

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Operator [21]

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The next question comes from Jialong Shi with Nomura.

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Jialong Shi, Nomura Securities Co. Ltd., Research Division - Head of China Internet & Media Research and VP [22]

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(foreign language) I have follow-up questions on the e-commerce, on our relationship with the e-commerce customers. First of all, I would like to know the price comparison for ZTO's different e-commerce customers. In particular, I just wonder if the average price ZTO charges PDD merchants, if that price is similar to or lower than the price ZTO charges those Tmall, Taobao merchants. And also we know Alibaba is one of -- is ZTO's strategic investor, so I just wonder if this closer relationship ZTO has with one e-commerce giant may potential restrict ZTO's capability to deepen the business cooperation with the other e-commerce players.

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Meisong Lai, ZTO Express (Cayman) Inc. - Founder, Chairman & CEO [23]

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(foreign language)

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Sophie Li, ZTO Express (Cayman) Inc. - IR Director [24]

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[Interpreted] From the price comparison, the price is largely driven and determined by the market. ZTO is a platform, so as Alibaba and Pinduoduo. There are many merchants and many consumers and also many of our franchisees on this network. Based on the market regionally, locally, they will negotiate price based on volume. And there are some deviation because of that and not because of manmade or intervention by any of the platform.

You are right that Alibaba is our investor, is our shareholder, but it has always been allowing us, and which is the right thing to do, conduct our business based on market practices. Our price is determined on cost plus/minus. And Alibaba has never asked us or it will never ask us to differentiate between them or any other of the market players. We are a open platform. We see everybody as the same, and we carry out our business as usual.

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Operator [25]

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The next question comes from Cherry Tan (sic) [Cherry Leung] with UIBKM (sic) [Bernstein].

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Cherry Leung, Sanford C. Bernstein & Co., LLC., Research Division - Research Analyst [26]

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(foreign language) In terms of the parcel volume, Alibaba still account for a big share in the first half. And as Alibaba stated in their recent result announcement, in second half, we expect strong e-commerce growth in Tiers 4 and 5 cities. So how do you see the e-commerce?

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Operator [27]

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Sorry, this is the operator. Your line is just cutting out.

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Cherry Leung, Sanford C. Bernstein & Co., LLC., Research Division - Research Analyst [28]

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Sorry? And will you be affected by slowing domestic consumption?

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Meisong Lai, ZTO Express (Cayman) Inc. - Founder, Chairman & CEO [29]

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(foreign language)

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Sophie Li, ZTO Express (Cayman) Inc. - IR Director [30]

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[Interpreted] It is our belief that e-commerce will continue to grow. And Alibaba being one of the largest player, of course, it will be the major driver for that. And the -- not only in the first- or second-tier cities, the rural areas including the villages presents great opportunity for express delivery industry especially for ZTO. We have the widest coverage and deepest penetration across the country. Our coverage in the villages, in the towns, are near 90%, so that provides great opportunity for us to benefit from the growth of that trend in the lower-tier cities.

The slowing of the commerce, what we've seen from our vantage point is that the e-commerce will continue to be the mainstream, although it may take on different format on offline coordination perhaps. And that's what we have referred to in our script that we will be building our comprehensive capabilities in serving those e-commerce or any of the variations there might be. E-commerce has been the driver for our express delivery business improvements or growth. And on the other hand, on the flip side, express delivery businesses is also providing positive catalysts to the commerce growth. So we don't think there is a risk. We are seeing more opportunity. And of course, the requirement is for us to continue to modify, if necessary, build new capabilities where needed in order to continue to grow with the market.

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Operator [31]

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Your next question comes from Parash Jain with HSBC.

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Parash Jain, HSBC, Research Division - Head of Transport Research, Asia-Pacific [32]

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I have 2 questions. One of the questions was already answered. First, can you share your view -- because in 2017, you have been recognized as national high and new technology enterprise. And as a result, we have seen a lower effective tax rate which is likely to expire by the end of this year. Do we -- should we expect a similar sort of extension going into 2020 and onwards. And my second question is, of your total CapEx guidance, how much of that would go to sorting center automation and investment in owned trucks. I recall you disclosed that in the past, but if you can help me respond that again, that would be really helpful.

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Huiping Yan, ZTO Express (Cayman) Inc. - CFO [33]

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Thank you for your question. Yes, we've been recognized as the high new technology company. And the cycle is 3 years, so we are in our third year. And based on our current business and also plan on investment on the technology, we will be renewing for that qualification, so hence, to continue to enjoy that beneficial tax rate.

Our CapEx spending, largely about 70% goes towards land acquisition and sorting facility development; about 20% -- around 20% or so will go towards investment into improving our fleet capability as well as some of the sorting equipment going forward; and then the rest will go towards technology and so on and so forth.

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Parash Jain, HSBC, Research Division - Head of Transport Research, Asia-Pacific [34]

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Okay. Just to clarify regarding the tax bracket, is it by -- it will be automatically extended for the next 3 year? Or is this something that you will apply and you have already got an extension for 3 years?

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Huiping Yan, ZTO Express (Cayman) Inc. - CFO [35]

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No, it is not an automatic renewal. We will be applying for it. And then also on a consistent annual basis, we'll be providing documentation and also receive necessary inspections from the government on an annual basis. So it is a process we continue to apply.

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Operator [36]

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Thank you. This concludes our question-and-answer session. I would like to turn the call back for any closing remarks.

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Sophie Li, ZTO Express (Cayman) Inc. - IR Director [37]

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Thank you, everyone, for joining our call. As you know, that we've been consistently executing on our strategy and have been demonstrating our ability to adjust to the market condition changes. And as we grow our business, we are also growing our footprint on the environment. And we wanted to let everyone know that we have published our first ESG report, and that is posted on our website. And that report for 2018 summarized some of the efforts that we have put forward in terms of environment, social and governance. Welcome everybody to take a look, and we will be seeing you on the road. Thank you very much.

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Huiping Yan, ZTO Express (Cayman) Inc. - CFO [38]

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Thank you.