LexinFintech Holdings Ltd. (LX) Q1 2018 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the LexinFintech First Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen only mode. I must advise you that this conference is being recorded today. I would now like to hand the conference over to your first speaker today Mr. Tony Hung, Senior Director of Capital Markets. Thank you, and please go ahead.

Thank you, operator. Hello everyone and welcome to Lexin’s first quarter 2018 earnings conference call. The Company’s results were issued earlier today and are posted online. Joining me today on the call are Mr. Jay Xiao, our Founder, Chairman and Chief Executive Officer; Mr. Craig Zeng; our Chief Financial Officer; Mr. Ryan Liu; our Chief Risk Officer; Mr. Stanley Zhou, [ph] our Senior Financial Director and other members of our team. For today’s agenda, Mr. Xiao will provide an overview of our recent performance and highlights. Mr. Zeng will discuss our financial results and Mr. Liu will discuss our credit performance. Before we continue, I refer you to our safe harbor statement in the earnings press release which applies to this call as we will make forward-looking statements. Also this call includes discussions of certain non-GAAP financial measures. Please refer to our earnings release which contains a reconciliation of non-GAAP measures to the most directly comparable GAAP measures. Finally, please note that unless otherwise stated, all figures mentioned during this conference call are in renminbi. I will now turn the call over to our CEO, Mr. Xiao, whom I will translate for.

[Foreign Language] Hello everyone. I’m pleased to announce that for the first quarter 2018, we were able to achieve another quarter of strong results. At the end of the quarter, our registered users reached over 26 million, doubling from a year ago. Our platform also originated over RMB 14.8 billion in loans, an increase of 98% versus a year ago. This was accomplished in a market environment with increasing change. Corresponding with our growth and loan originations, our net profit also achieved strong growth, reaching RMB 146 million, an increase over 160% versus a year ago. I believe that our strong performance is, first and foremost, the direct result of our stable and highly compliant business model. Since the founding of our business, Lexin has been a business built on consumption scenarios, and we were China’s first dedicated installment purchase e-commerce platform, serving China’s high-quality, high-growth potential customers. It’s due to use of consumption scenarios in our business that we acquired our high-quality, high-growth customers. And it is by serving these customers with our low APR consumer finance products that we will continue to build our competitive advantages in a new regulatory environment. Our strong performance is also a direct result of our long-term commitment to and our past investment in our financial technology. We spent approximately one-third of our operating expenses on the research and development of our financial technology. These investments have allowed us to achieve greater operating leverage as we continue to grow. In 2015, Lexin’s operating expenses represented 17.5% of our average loan balance. In 2016 and 2017, this figure was reduced to 8.9% and 5.8%. For the first quarter, this number was further reduced to 4.5%. Today, Lexin is fully utilizing AI and the latest technologies in every part of our business and substantially improving the efficiency of our service. Today, over 98% of all our transactions can be processed automatically with the assistance of our AI technology, allowing us to greatly reduce the need for traditional labor hours and work. Our stable growth strategy and high-quality customer cohort has allowed us to win the trust of evermore financial partners. In a new regulatory environment, where technology companies will be responsible for technology and financial institutions will be responsible for financing, cooperation between financial technology companies and financial institutions will become a major trend and a trend that regulators are encouraging. Financial institutions have a strong brand and reputation, scale advantages and funding but however lack consumption scenarios, expertise and customer experience and widespread reach. In particular, in smaller sized transactions, traditional financial institutions lack operating efficiency. However, what traditional financial institutions are not good at is exactly what financial technology companies are good at, which gives both sides a strong basis for cooperation. In the past year, Lexin’s Hawkeye credit system, Wormhole matching system and other technology systems have continued to gain the trust and recognition of more financial partners. In the first quarter of 2018, our loan facilitation servicing fees reached RMB 164 million, an increase of 204%. We believe that our cooperation with various financial institutions will create even more value and contribute to Lexin’s continued growth. Next, I’d like to invite our CFO, Craig to discuss our most recent financial performance. Thank you.

Thank you, Jay, and hello, everyone. I’m pleased to announce that we have continued our robust growth trend and delivered a strong performance on our first quarter 2018 results. Our strong performance is a reflection of our commitment to provide a superior customer service to our educated young adult customers in China and to continue to grow with our customers and our partners. We have seen a demonstration of this growth, the performance of the cohort which we acquired in the fourth quarter of 2015 whose balance has risen to over RMB 10,500 and whose 30-day delinquency rate is about 1%, while maintaining a stable level of quarterly active rate at 46.5%. Overall, our average credit limit has increased to over RMB 8,600 while our tenure has increased to over 11 months. And our effective APR was at 23.4%. Our total loan originations in the first quarter reached RMB 14.8 billion, up 98.3% from RMB 7.5 billion from a year ago. Our total outstanding loan balance reached RMB 21.3 billion, up 99.35 from RMB 10.7 billion for the same period 2017. Total operating revenue for the first quarter reached RMB 1.6 billion, driven by strong financial services, income growth, which reached nearly RMB 1 billion for the quarter. Loan facilitation and service fee increased by 204% from RMB 54 million in the first quarter 2017 to RMB 164 million in the first quarter of this year. Funding costs increased by 46.1% from RMB 176 million in the first quarter of 2017 to RMB 257 million in the first quarter of this year. The increase was primarily due to the increase in our funding debt to support the on-balance sheet loans originated on our platform. At the end of the quarter, approximately 61% of our funding came from our usually tight [ph] platform, and 39% of our funding came from our institution funding partners. Our overall effective funding cost was 8.6% for on-balance sheet portion of our portfolio for the quarter. Processing and service cost increased by 49.4% from RMB 44.1 million in the first quarter of 2017 to RMB 65.9 million in the past quarter. Provision for credit losses increased by 135% from RMB 122 million in the first quarter of 2017 to RMB 287 million this past quarter. The increase was primarily due to the increase in the average outstanding principal balance of our on-balance sheet loans. As a result of our strong growth, gross profit for the first quarter reached RMB 412 million, representing an increase of 52.2% from the year before. Sales and marketing costs increased by 17.5% from RMB 86.4 million in the first quarter of 2017 to RMB 102 million in the first quarter of 2018. The increase was primarily due to the increase in payroll and advertising cost. Our sales and marketing expense continue to reflection our highly efficient and cost effective customer acquisition strategy. Customer acquisition costs per active customer were RMB 108 for the first quarter 2018 and we acquired over 440,000 new active customers in the first quarter. Research and development expenses increased by 54% from RMB 44.2 million in the first quarter of 2017 to RMB 68.1 million in the first quarter of 2018. This increase was due primarily to the increase in payroll, depreciation, rental and share-based compensation. General and administration expense increased by 37% from RMB 42.9 million in the first quarter of 2017 to RMB 58.6 million in the first quarter of 2018 due to the increase in payroll and the share-based compensation. Net income for the first quarter was RMB 146 million as compared to RMB 56.3 million a year ago. Adjusted net income was RMB 174 million, an increase of 88% from the first quarter of 2017. Net income per ADS for the first quarter of 2018 was US$0.13 on a fully diluted basis. Please note that the EPS calculation in many consensus calculations was not correct. As they are pulling the GAAP EPS number to compare to the non-GAAP EPS number and using the incorrect unadjusted share count to calculate the consensus EPS. Please note the correct share count numbering in our financial statements. Our non-GAAP EBIT reached RMB 211 million, which was an increase of 67% compared with the same period in 2017. As Jay mentioned, in the quarter, we continued our improving operating leverage. Operating expenses as a percentage of average loan balance decreased to 44.5% in the first quarter. Now advertisement marketing, advertising, G&A and R&D decreased to 1.5%, 0.5%, 1.2%, and 1.3% of average loan balance respectively. We currently have over 26.4 million registered users with nearly 8.2 million with credit line current losses, up from 7.6 million at the end of 2017. For our guidance, Lexin’s expects the total originations for the fiscal year 2018 to be approximately RMB 80 billion. This is our current and preliminary view which is subject to changes and uncertainties. Next, Ryan will discuss our credit situation. Ryan, please?

Thank you, Craig. In the first quarter of 2018, we continued our strong focus on credit control and acquiring the right customers. Our strategy of processing on acquiring educated young adult customers continues to play off in our strong credit performance. Our 90 days plus delinquency ratio remains low at 1.44% and we continued to face strong performance as our life time charge-off ratio continues to remain at around 2%. In the first quarter of 2018, our NPL ratio for off-balance sheet loans was 1.67% and our NPL coverage ratio 198.8%. In addition, we have seen the strength of our strategy in growing with our customers. As Greg mentioned earlier, our increased ratio caused the cohort which we acquired in the fourth quarter of 2015 continues to be low at only 1%. With that, I conclude our prepared remarks. Operator, please proceed.

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] We have the first question from the line of Miranda Zhuang from Merrill Lynch. Please ask your question.

[Foreign Language] Thanks for taking my questions. I have two questions. The first one is about funding sources. So, it seems that the mix of funding from institutions decreased meaningfully quarter-over-quarter. Can you share with us the trend that you have seen in this funding channel and how do you study to impact your funding costs? And the second question is, can you just share with us the mix of e-commerce related loans versus the cash loans in your outstanding loan balance and in your loan origination amount separately? And what kind of trends have you seen in these two types of loans? Lastly, can you disclose difference between the delinquency rates of the e-commerce related loss and cash loans? Thanks a lot.

[Foreign Language] So, answering the first question with regards to the trends on the funding sources. I think, it’s first worth pointing out that there is a seasonality when it comes to the traditional financial institutions. And at the beginning of the year, they tend to put out less amounts. And the amount set by the government is not official yet, they are still waiting for orders. Also simultaneously at this time, our P2P [indiscernible] management is particularly popular at this time after Chinese New Year due to the fact that there are many people with bonuses and additional cash amounts that they need to invest. So that’s couple of the main reasons. Another reason is due to the regulatory where many institutions were waiting and watching a little bit. But since then, we’ve seen that they have digested fully the regulatory implications. And once again, we’re growing the amount of money that we are sourcing from institutions. In fact, we’re adding something like two or three institutions a month. So, I think in the future that will be reflective in the second quarter numbers as well. And you can see from our performance in the first quarter and in the environment, the strength of our strategy and the funding sources how are able to manage our growth in spite of changing regulatory challenges, still having diversified sources and being able to be more compliant than our peers when it comes to the current regulatory environment. So, I think this is a strong reflection of our strategy. So with regards to your question on ecommerce versus non-ecommerce loans, I think it is worth pointing out that in terms of credit, whether it’s how we approach it how credit is done in general, credit in the space time the user and the borrower, it’s not based on the consumption scenario per se. We do offer consumption scenarios, it’s obviously impossible for one side to offer all the consumption scenarios that are possible out there. And ultimately when we look at credit, it’s going to be based on the individual. And not surprisingly, because it is based on the individual, whether the individual is borrowing for a specific ecommerce purchase or drawing down cash events, the credit is the same. So, there is no real differences when it comes to the credit numbers. If someone withdraws cash flow their particular line with us and spends it on another ecommerce site, we actually don’t see any differences in terms of the credit profile. Because again, credit is based on the individual; it’s not based on a particular scenario. So, we actually see the same credit statistics. So, hence really, there is no fundamental difference when it comes to the credit profile of ecommerce scenario versus a non-ecommerce scenario.

The next question comes from the line of [indiscernible] from Goldman Sachs. Please ask your question.

[Foreign Language] So, I have three main questions. Firstly is on the off-balance sheet loan facilitation fee rate. We calculated that in terms of quarterly fee rate, the fee rate seems to be lower versus previous quarter. We wonder if there is any specific reason. For example, if the banks are less willing to pay out right now? And secondly, the second question is on P2P registration process. We wonder if we still aim up for the June registration process. And thirdly is on asset quality. We see that delinquency rate has risen to 1.44%. We wonder if we still expect to rise steadily going forward and in a medium to longer term what’s the level that we are looking at? And correspondingly, regarding the loans that we work together with banks, is it possible that we don’t carry the credit risk anymore? Thank you.

Yes. Thanks. Regarding our first question, let’s say we see the rate, [ph] actually it’s in a reasonable range we’ve been wanting, it’s different time and different negotiation with the different funding partners speculating in a low quarter for the funding partners. So, it’s some kind of fluctuation on the rates and on customers on the first quarter on what kind of assets, we may [ph] provide for those funding sources. So, it could be a little fluctuation. Also, this different provision rate also impacts this number. But we see the number actually not increasing much. So, we’re stilling seeing the same rate. So, you will see a little change up and down among different corners. That’s basically in the same level.

[Foreign Language] So, on the whole P2P registration top, it’s clearly one where everybody is focused and certainly we’re focused on it as well. Now, unfortunately, there is no new update on the government and overall the situation isn’t that clear per se. Now, the market rumor is of course that it is delayed and we have heard the rumors as well. But, on our end, what we like to emphasize is that we’ve been fully ready, we’ve been ready to receive the government and we’ve been ready to take on the process and to fully comply. But right now clearly under the time table, it hasn’t really begun at the level that we will like to it. So, the process in that sense is delayed. Now, that said, whenever everyone is ready to begin the process formally, we’ve been fully ready for long time and we’re more than ready to -- in the very, very first instance to deliver everything that the regulatory authorities may need. And so, as Ryan indicated, actually our credit quality is definitely stable and everything is very much within range, even if they might be up a little bit. Overall, the provisions are up and some other things are up. It’s not something that we haven’t seen before for this particular quarter. So, it is very much seasonal in some respects. Now, since December last year, we have seen some changes in the industry, some impacts to other players in the industry. But because of the fact that we focus on high-quality customers, our educated young adult customers, there has been very limited impact on us. With regards to your second question, getting more financial institutions to take more of the credit risk that is definitely something that we’ve been looking to do and in fact have succeeded a little bit. We believe that in the future, we may continue to succeed in that aspect.

Thank you. The next question comes from the line of Bo Pang from China Renaissance. Please ask your question.

[Foreign language] So, I have three questions basically. The first one is about the regulation. So, there are two aspects of my question. The first one is about our very strong performance in P2P in first quarter. So, I just wonder whether regulators will have some potential pressure over our growth down the road. And number two, or the second aspect of regulation question is about the loan facilitation business. I know, we have been doing very well, partnering with our funding partners. However, I also noticed that there are a lot of competitors with ours also rushing in this model. So, I just wonder whether regulators will allow this rush going and will have any potential pressure on this model as well. My number two question is about the user acquisition. I just want to get an idea on how should we think about the resource allocation between accumulated [ph] customer and new potential user acquisition initiatives. And whether we are thinking about to develop more user scenario to keep growing our ARPU and acquire more down the road? And my number three question is about the guidance. So, I know we have our full year loan volume guidance of RMB 80 billion. However, I want to have a rough breakdown in terms of the active borrower accounts and ARPU growth. And also I want to have an idea on split between the P2P volume and the institutional funding as well. Thank you.

[Foreign Language]

Yes. So, regard to your question on regulations, the first part regarding the P2P, clearly in the first quarter showed a significant growth as a percentage. But within this context, what we would like to emphasize is that we are fully compliant and this growth was also fully compliant with the rules and regulations. What the government has gone after is the non-compliant P2Ps and the non-complaint numbers that are out there that need to be reduced. And the government is requesting limits on the growth of that non-complaint portion of the P2P business. Also, we have to say that being and centered in a more massive and progressive city where the government is very much supportive of our business, we’ve been perhaps enabled to do a little bit more. But now, within the context of our overall funding what I would like to emphasize is that as financial institutions become more comfortable with the new regulatory environment, they will increasingly come back and our P2P portion will potentially decrease as well. Ultimately, when it comes down to whether to use our P2P or traditional financing [ph] resources, we’re going to obviously seek to have as many diversified funding sources as possible. And it will come quite often ultimately to the cost of funding. And we believe, based on the trends that we’re seeing from the institutional side that institutions are becoming more and more comfortable and the cost of funding from institutions may come down as well. With regard to the second part you asked about regulatory environment, which is the loan facilitation model. As I mentioned earlier in my prepared statement, the loan facilitation model can be considered to be a mega trend for Chinese fin-tech. But however, loan facilitation also needs to be fully compliant with the regulations in place. And on that note, we are fully compliant, and this is why we believe you’ll see that there’ll be more funding institutions and traditional financial institutions coming back to us. And we believe for the second quarter in the future, you’ll be able to see that in our numbers. So, with regards to your second question, customer or user acquisition, it’s probably worth pointing out again that the key to our growth is not in acquiring new customers. The key to our growth tends to be from our old customers. Our older customers is a bigger contributor to our overall growth than the acquisition of new customers per se. And this is a reflection of numbers. So, this is something that’s actually very different in that sense. With regards to your question on a whitelist, we’re not like the big platforms with a whitelist per se because we begin the process very differently by picking high-quality educated young adult customers. And these are customers that we pick out very carefully, will have stable credit performance to begin with. So to begin with, this is actually quite different than perhaps what you’re seeing and heard from other platforms. Now, with regards to the customer acquisition, we continued to see in the first quarter actually that a substantial amount of our customers is coming from referrals. And this is again because our customers tend to be geographically concentrated and have similar needs, similar issues, similar desire for certain consumer finance products. So, hence due to referral, we can serve more customers that way. Now, in terms of your question on new methods for acquiring customers, we’ve seen increasing growth with our partnerships, with third party ecommerce sites. And by working with third-party ecommerce site, we’re creating new consumer finance products to help their customers. So, we see saw a decent growth there in the first quarter. Also, we’re seeing increasing cooperation with traditional financial institutions. So, for example, we have features in their apps whereby we help their existing customers and give them products that otherwise they didn’t have before. And this in turn helps us acquire new customers as well. But within all this context, we’d like to emphasize that when we acquire customers, it’s on a very strict basis and focus on high-quality credit. Regarding your third question, our guidance, we have more [indiscernible] on our business, because a large part of our growth is coming from the growth of our existing customers. Regarding new customer acquisition, we have improved to have very effective ways to acquire new customers and it’s been very stable. So from the funding side, we see definitely our forecast was based on couple of things. First, like registration, we will be impacted by registration of P2P platform, will be more stabilized revenues or environment. But overall, because we have our diversified funding strategy, so our funding sources relatively have more kind of risk resistance compared to the others.

The next question comes from the line of Mr. Ryan Roberts from MCM Partners. Please ask your question.

Good evening, management. Thank you for the opportunity to ask a question. I also wanted to follow up on the guidance issue, guidance for the year. It seems like a lot of the growth you mentioned before from your existing customers. And one of the things I was wondering about it at the loan side, the average loan balances, as those creep up with your existing customers, I would think the consumption scenarios also will be changing in terms of the more larger size takes purchase items as opposed kind of ecommerce model, it’s been pretty popular historically. I’m just wondering on the product development front, can you give us any kind of color what you’re doing there? I can see your competitors are pushing into different loan sites. I’m just curious how you are look at that in the development or in the landscape and kind of what your approach is to that? Thank you.

Thanks, Ryan. Let me translate first. [Foreign Language]

So, in terms of how we approach things, as you know, we have always approached things from the needs of our customers and how to serve them better. So, whether it’s from the very beginning when we started off with providing financing services for the purchases of smartphones to later on to other items whether it’s PC, laptops or even apparel, it’s always been the customer that has been at the center of our business. This year, what we’re seeing increasingly in terms of new products and new product development and new consumption scenarios is an increasing, for example travel, whether it’s hotels or vacations. But ultimately, it’s all going to come back to the needs of customers and our ability to serve them. And this is how we will maintain their activity level on our platform.

Okay. Thank you. If I could ask another question just about the -- maybe this is more for Ryan, on the risk control. So, we see this 90-day delinquency rate increased a little bit in Q1? I’m just curious in terms of the credit event that happened at the end of the last year. That’s reflective of that. And furthermore some of the -- I think you mentioned some of the changes and some of the new enhancement to credit decision that you were implementing. I’m sort of curious if you can give some more color on that aspect.

So, let me translate that briefly. [Foreign Language]

All right. Yes, the delinquency ratios right now are a little bit in Q1 and I think that’s mainly driven by two different reasons. One is [indiscernible]. As you know, normally the Q1 of each new year is -- our delinquency ratio will be a little bit high because the Chinese New Year and also February we only have 28 days. So, actually everything will be impacted. Another main issue is also a mix, the tightening of the parties. [Ph] And if we are looking at the last year and the government [indiscernible]. So, although we’re pricing the overall the educated young adult, the total will not be impacted significantly. But there is a small part of our portfolio a little bit impacted. So, part of that is not a big reason. [Ph] So, mix together, the delinquency ratio of 90 days backing up a little bit, but it is still in a normal range. We’re comparing to our last year, 2017, the half of June, the first half of year and 90 delinquency ratio is also 1.42%. So, that number is still within the normal range. We are very comfortable with that.

Okay. And just to maybe get a little more color on that if possible. So, you added 440,000 new customers in Q1 this year, 570 in Q4. So, I’m just kind of curious who are these -- I guess the impact of the delinquency change, is that new customers or is that existing customers? It looks like existing customers. And I’m just curious again what kind of changes and how you’re doing risk control and perhaps or maybe credit decisioning for whichever group that is. And I’m assuming it’s the existing customers. Any kind of color on that would be helpful.

Okay. That is the mix of new customer and the existing customers. Majority comes from the existing customers. But as I mentioned earlier, it is mainly the seniority [ph] issue. So if we’re looking at like next to couple of quarters, it will be flat.

Okay. It will be flat with Q1 or it will be flat with the earlier trends?

If you’re looking at our whole portfolio numbers, it’s 1.4% that is a normal range, it’s within range. So, you’ll see we are also doing a lot of tests. So, we are comfortable with that.

The next question comes from the line of Jacky Zuo from Deutsche Bank. Please ask your question.

[Foreign Language] I will translate my question. So, first of all on cost control. It’s a pleasure to see we continue to lower our credit -- our cost ratio. So, what drove the down the credit cost? And looking ahead, which area we will see a larger decline in terms of cost? Second question is about the P2P quality assurance program, are we still doing this or we are in the process to switching to like other guarantee form? So, are we still using annualized 4.5% in terms of this quality assurance program? And third question is about the new credit products. So, are you doing this credit card balance transfer? How we are thinking about sort of new credit products? Thank you.

Thanks, Jacky. It is Craig. We -- regarding your first question on cost control, we [indiscernible] from all respect of our cost structure, but in different kind of levels. The highest growth area is R&D. R&D will be less leveraged, because we are keeping investing in R&D in our business. But in other places G&A and non-advertisement sales and marketing, all those areas, we’re expecting to see some leverage. So overall, you can expect that number will keep down as we have been down in the past couple of years. Regarding your second question on B2B platform, we did work with guarantee company -- insurance company and the rate is maintained, 4.5%. In this area, we will see what the regulatory requirement is, we’ll follow the instruction to be compliant. Currently, [indiscernible] our rate still will be 4.5%.

[Foreign Language] With regards to new product and specifically the one you mentioned on the credit card transfers, it is a product that we have in place since last year. And we can see that recently and also last year there has been good growth in that business segment. So, it is definitely something we’ve done and we’ve also seen good growth in. Thank you. Operator?

So, shall we take the next question?

Please.

The last question comes from the line of Vicky Wu from ICBC International. Please ask your question.

[Foreign Language] How does management think about competitive landscape at other ecommerce companies and online travel platforms also take online consumer financings and important new revenue driver? Thanks.

[Foreign Language] So, thank you. With regards to your question on competing with other ecommerce platforms, I mean, it’s always worth noting that we don’t do things based on the market, but rather we base it on our customer. We’re very much customer centric. And it’s not like in the past JD or Taobao or others have not competed with us and have not offered similar scenarios or products. But instead, it’s because we have a very customer and consumer focused approach to things, we’ve been able to differentiate. So, as an example, as we’re growing with our customers, the product that we’re seeing that they have the desire for is for travels for vacations. So, hence naturally, we’re growing with them in this particular process. Now, as we’re putting together the packages and products for our customers, we’re approaching it as we have before within asset light model where we’re working with third parties. So, as we’re serving the customers well and the customer is on our platform that we can continue to off them these set of products at better terms. It’s worth noting that if these customers then try out other platforms, they might actually get very limited amounts of credit, because of their limited credit history with the other platforms if they even have any. It’s also a much longer proof process when they have to fill out multiple forms to prove that they are a good credit. Whereas on our platform as our existing our customer, all it takes is literally a couple of steps [ph] to get what they need. So, hence, this is a thing that very much differentiates us from our peers who are entering the market. Operator?

Thank you, sir. Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect your lines now. Thank you.