X Financial (XYF) Q3 2018 Earnings Report, Transcript and Summary

Good day, and welcome to the X Financial Third Quarter 2018 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Jennifer Zhang. Please go ahead.

Thank you, operator. Hello, everyone, and thank you for joining us today. The company results were released earlier today and are available on the company’s IR website at ir.xiaoyinggroup.com. On the call today from X Financial are Mr. Justin Tang, Founder Chairman and CEO; Mr. Simon Cheng, President; and Mr. Kevin Zhang, Chief Financial Officer. Mr. Tang will give a brief overview of the company’s business operations and highlights, followed by Mr. Zhang, who’ll go through the financials and guidance. They’re all available to answer your questions during the Q&A session. I remind you that this call may contain forward-looking statements 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 factors, of which are difficult to predict in a manner which are beyond company’s control, which may cause 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. Justin Tang. Mr. Tang, please go ahead.

Yes. Thank you, Jennifer. Hello, everyone, and thank you for joining us for our first earnings call as a public company. I’d like to take this opportunity to thank our shareholders, as we’re now publicly listed on the New York Stock Exchange. Our IPO is an important milestone in our corporate history. We consider the giant step forward in our mission as we utilize big data and Internet technology to build our leading personal finance company in China. We are very early in our growth curve, and we believe in the long-term, there is tremendous potential in this market. In the near-term, I think, the major theme is that economic outlook in China remains uncertain. In the near-term, I think we have three major focus. Our number one focus is to preserve shareholder value during an uncertain economic environment. Our number two focus is to operate our business under the highest the compliance standards as possible to ensure we are fully complained in the upcoming implementation of our new regulatory standard. Our number three focus will be to deliver a healthy and sustainable revenue and net income growth. Let me now turn to our performance for the first quarter of – for the third quarter of 2018. I’m pleased to report the strong financial and operational results in our third quarter – in our first quarter as a public company, with net revenues increased 83% to RMB830 million and adjusted net income more than doubling to RMB249 million. Our businesses continue to recover following the lows we saw in July, when the market turmoil was at a peak. We expect this trend to continue going forward. Total loan facilitation is gradually improving. We are decreasing by about 13% during the quarter, year-over-year and 32% sequentially from Q2 this year. We expect the total loan facilitation in the fourth quarter to increase sequentially from RMB7.6 billion this quarter to between RMB8.0 billion to RMB8.5 billion in fourth quarter. On the regulatory front, I think, there’s some good news. I think, the regulatory policy today is more visible and more friendly than any period over the last couple of years. We were one of the first P2P platform to submit our P2P Compliance Self-Inspection Report before the deadline. This is the first step to gain full compliance with industry reform the government has been rolling out through the National P2P Rectification Offices. And recently, [governor body] [ph] have mentioned more than a couple of times, online lending, P2P lending, an important part of China’s financial system to provide credit to individual and small business. We fully support government’s initiative and are working closely with them to create a healthier and more sustainable environment for P2P platform. We continue to strengthen risk control across our platform. If you look at our Q3 results, we have a decline in loan facilitation, that’s mainly due to two drivers. Number one driver is the lack of funding during the July and August time. That actually is already over. Right now, we have very sufficient funding. The number two driver is we consciously reduced our average loan size because of our concern of external economic environment and credit environment. So if you look at the average loan size that we have on our credit card loan during the Q3, we cut it down by about 20% from our normal period. After IPO, we started to invest more aggressively in our brand. Historically, actually our company have not invested too much in our brand, but we feel during the industrial downturn, it’s a good time to invest in our brand. Recently, we signed a multi-year marketing partnership with NBA, which we will see our brand integrate with their whole marketing and media platforms. It is NBA’s first time to cooperating with a company in China’s online lending P2P industry. We appreciate the core value the NBA represents, and we shared the same vision with NBA, which is encouraging people to chase their dreams. As of today, our online lending platform still provide for most of our funding. At the same time, actually there are more and more financial institutions recognized the quality of our product and want to partner with them. Recently, we started to have a partnership with CITIC Trust, which is one of the China’s largest trusted company. And this important cooperation – this important cooperation is a good opportunity to leverage our advanced technology and extensive experience in operating online lending platform to assist the CITIC Trust in acquiring qualified borrowers and facilitate loans. Together, we’ll jointly develop a new data-driven credit assessment system that combined CITIC Trust was among the borrowed credit data with our big data analytical capabilities and technology. Overall, we strongly believe we are ideally positioned to benefit from the enormous growth opportunity in China’s online lending industry and we’ll continue to execute our strategy to generate long-term sustainable value to our new shareholders. With that, I will turn the call over to Kevin, who will go over the financials. Thank you.

Thank you, Justin. Hello, everyone. For the third quarter of 2018, we delivered a solid result despite a difficult market environment. We continue to invest heavily in our risk management systems, product development, mobile platforms and big data analysis capabilities to further strengthen our credit rating ability to carefully manage risk, as the marketing environment has gradually improved. I will have a brief on our – on the financial update. For the interest of time, I will not go through every line items, but focus on the key ways. You can refer to more details in our earnings release. Our net revenue in the third quarter of 2018 increased by 83% to RMB830 million from RMB453 million in the same period of 2017, primarily due to a change in product mix resulting from a significant increase in the proportion of the revenue generated by Xiaoying Card Loan, which carries a higher service fee rate compared to the company’s other products. But when comparing to the results in Q2 2018, our net revenue declined by 22%, while the loan volume decreased about 32%, due to results around the increase of our [indiscernible] take rate from 9.5% in Q2 to 11% in Q3. But for better comparison, I would suggest to use adjusted revenue take rate [indiscernible], which equals to our revenue net provision for accounts receivable and the change in fair value of financial guarantee derivative. The adjusted revenue take rate is quite strong 8% in Q2 to 8.9% in Q3. Our origination and servicing expenses in the third quarter of 2018 increased by 40% to RMB284 million, compared to the same period result of 2017, primarily due to the increase in customer [indiscernible] from [credit size], share-based compensation expenses and the increase, including our collection expense, yes. Compared to Q2, I would say, it remain unchanged in the total month, but equates from 2.6% of loan volume to 3.8% of loan volume in Q3. It is because a large portion of the origination cost is a fixed cost, that means that – our labor cost. Sales and marketing expenses in the third quarter of 2018 increased a lot both by the amount and the percentage of low volume, primarily due to an increase in our advertising campaigns aimed at strengthening our corporate image and increase investor confidence such as the IPO Year Event and the NBA sponsorship. I would like to highlight the income tax expense during this quarter. The effective tax rate decreased a lot due to the corporate income tax rate applicable to our major subsidiary of the company adjusted to 15%, and we also expect our pre-tax additional deduction for R&D expenses recorded in the third quarter of 2018. Our net income and our non-GAAP net income in the third quarter of 2018 was RMB198 million and RMB249 million, respectively, about double or more than double in the same period of 2017. On the balance sheet side, our cash and cash equivalents as of September 30, 2018 was RMB1,460 million, above an increase of RMB840 million from both the net proceeds from IPO and the taxes generated from our operating activities. This concludes our prepared remarks for today. I would now like to turn the call over to the operator to begin the Q&A portion of the call. Yes, please go ahead.

Thank you, Kevin. At this time, we’d like to open up for the QA. Please note that our Chairman, Mr. Tang; and President, Simon; and CFO, Kevin will take your call. Operator, please.

Okay. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Jacky Zuo with Deutsche Bank. Please go ahead.

Hi. Morning, management. Thanks for taking my questions. This will have two. One is the asset quality, I saw during the quarter, the 30 to 90-day [indiscernible] ratio rose to about 3%. Just want to get a sense about the rising – short-term delinquency ratio. And I saw we proactively shortened the – sorry, to lower the ticket size of our car loan. Is that because of we’re actually seeing some asset quality pressure from our borrowers? And what’s the outlook and trend going forward? Secondly, the question is on the – more than guidance. Our guidance imply us around 6% to 12% quarter-on-quarter volume growth. And we understand fourth quarter is actually traditionally, it’s a peak season for online borrowing and the credit card loans. So just want to get some sense of the reason behind our kind of softer than expected guidance and also is good to share what’s the mix of the loan volume, like what percentage of the loan volume will come from car loan and also from preferred loans? Thank you so much.

Yes. Simon, maybe you want to answer the first question, and I answer the second question.

Sure. This is Simon. Hello, Jacky. For the significant increase and there are majorily two reasons. One is actually, we are at a high-growth momentum. So the business grow as we will see the delinquency grow as well – is about [indiscernible] delinquency later. This is one of the driver. The second driver is, yes, we saw an increase in delinquency in our product. So that’s the second driver. Majorly, actually, in the car loan, we saw a slight increase in the delinquency, but it’s only the slight delinquency.. We actually believe our credit card fee for car loan, our major revenue and profit contributor actually is – and still and our early projection projection. We will adjust our credit policy – we tight our credit policy starting from Q3, not only we lower the [indiscernible], but also, we increase – we reject more applications. It’s more like a prevention action. We anticipate a more difficult economical environment in Q4 and next year. We want to make sure our credit quality for car loan actually still and our projection. We can have a stable credit quality in our portfolio. We can have a stable margin, risk-adjusted margin. We can have a stable revenue and profit. It’s more a prevention actually for the – for our car portfolio. Again, we will still believe the car portfolio – the credit card key and our early projection, we have still maintained the same healthy risk-adjusted margin going forward. Our preferred loan actually, we do have a higher delinquency inclusively than before, and that is a challenge for us. That’s actually challenging for us, because for the borrowers – for the preferred loan borrowers, they are pretty much micro small business owners in China. For the micro small business – micro small business in China actually is under – is a weak sector throughout all these economic downturn. We understand that all these private sector and future pressure from the deleverage [indiscernible] average process. And this micro small business owner – owners who borrow unsecured loan, this is either [indiscernible] where the weak point of the holder credit chain. So they are in each pressure and the liquidity and the ability to borrow and the ability to pay, because they are business partners also and pressure. So we do see a very, very high increase default. So that – that’s also the contribution for the delinquency decrease in the pre-quarter loan. And from that perspective, we basically scale down the business, our preferred loan. And that will lead to higher delinquency ratio as well, because you stop rolling the business. Your order business still have a delinquency and that was also the driver for the increase in delinquency.

Yes, Jacky, for your second question is, the Q4 loan facilitation grows. Like I mentioned in my call, basically, I say our near-term key focus number one is to preserve shareholder value, because I think one of our key ability is closely monitor the data and real-time adjust our strategy and policy. So we will be able to manage our risk on the very much real-time basis. So in the near-term, our characterization of external environment is uncertain economic environment and the challenging credit environment. So the results at this moment, we don’t want to put the growth in our number one priority. Our number one priority is to preserve shareholder value. At the same time, I still say number three, we will continue to generate a healthy and a sustainable growth. So that’s our operating forecast. If you look at the underlying driver, like Simon also mentioned, actually our credit card loan, we are continuing to grow in terms of number of loans being facilitated. But at the same time, we reduce average loan ticket size by 20% to even 25%. So although, the loan amount continue to grow, but combining with the lower ticket size, the growth in loan facilitation amount is not that obvious. Then on the preferred loan because of the operating environment for SME owners are very difficult these days, and our preferred loan did suffer a higher than expected loss than our early estimate. And as a result, actually, over the last three quarters, we have been consistently reduced our preferred loan business. As you know, we’re keeping saying is, if you look at the core competence of our company, core competence of our company is using and use data to the different – to the differentiate risk of pricing. So in the future, if you look at our core business really is online loan facilitation, use data and Internet technology. So based on what we’re seeing and what’s our plan at this moment, we target RMB8 billion to RMB8.5 billion for Q4. Certainly, we hope to do better.

Thanks a lot. Can I have a follow-up question on the delinquency rates? Can – is that possible to share the breakdown of what was the delinquency rate for car loan and the preferred loan just to make sure I understand this correctly?

Simon, do you want to answer that?

Yes. Actually, at this moment we don’t have – we don’t share the separate delinquency for each product. But our general guidance is our delinquency and the loss for car loan actually is pretty consistent as before and our IPO and our estimate, and preferred loan is much higher than our estimate. And we don’t have – we don’t share the detailed break-down about the general picture of the situation. And other – our one big [indiscernible], because we scale down the preferred loan business. The mix of our portfolio actually, the servicing portfolio actually is more [indiscernible] in the car loan.

Got it.

Yes, Jacky. When we – you look at it – if you look at the longer newly facilitated loan, our car loan is a dominant part of our business. Our car loan now is probably almost every month is probably, like in terms of around like 10 times our preferred loan amount, so in a newly facilitated loan. So to understand our business on a going forward, you should just focus on a car loan. For the existing loan book, because our risk are fully provision and fully being sell to the – covered by the insurance company. So you actually don’t need to worry about it the existing loan book that much. I think, that’s the reason, I think, we feel this is a better way to present our business just on a combined basis, yes.

Sure. Thank you. Thank you so much.

[Operator Instructions] The next question comes from John Cai with Morgan Stanley. Please go ahead.

Hi. Good morning, management. I have two questions. First is on the adjusted net take rate and we see an improvement on the Q-on-Q basis to around 8.9%. So I understand there’s a product mix shifting towards the car loan higher fee rates. So I just wonder if there’s other reasons driving up the net take rate and can we have more colors on the APR and provisions and funding costs, a breakdown of the net take rate? And then the second question is on the cash balance. After the IPO, we have pretty sufficiently liquidity with around RMB1.5 billion cash. So just wondering how we want to utilize the cash? Thank you.

Hi, John. Yes, I will take the first one and the second one first. Yes, [indiscernible] relatively, yes, you’re absolutely right. Our relative bridge includes Q3 when compared to Q2, mainly for the change of the product mix and with proportion of our car loan in our loan book. But on the forward-looking, we do expect that we will have some slight increase to our APRs in the Q4 in 2019. But mainly due to our traditions when we look at the total credit environment and potential risk exposure. So – but currently, we are able to [indiscernible] adjusted revenue in Q4 – take rate where we make stable when compared to Q3, yes. So, our second question was delinquency, yes. Now we have forecasted [indiscernible] the increase in our cash in Q3 is both from the occupancy and our net – and our – the cash generating for operating activities. We are training for how to better utilize our cash. For example, we are looking for – to more investment in our advertising and those much activities, such as NBA and other activities. And at the same time, we – I believe we will keep investing our human capitals in-depth of our key driver that differentiates us from other companies. And currently, we just had results to major objects to reduce our cash. And we will keep you posted if we have any business issues, if any, the acquisition or other kinds of use of our proceeds that we will keep you posted. Thank you.

Yes, John, just to add – yes, this is Justin. Yes. So, as you can tell, we obviously have a strong balance sheet with a bunch of cash and no debt. And our business continues to generate cash as well. So we will come to evaluate what’s the best way to use our cash to generate the best shareholder value. I think we are very open-minded, and the external environment obviously is very dynamic. But we will very much evaluate what’s the best way to utilize that to provide the best value to the shareholders.

Okay. Thank you.

Okay. The next question comes from Michelle Lee with AMTD. Please go ahead.

Thank you, management. I have two questions. The first, on the funding side. Could you please share with us your plans in terms of the funding mix? Do you plan to maybe expand your funding from the financial institutions as well? Second is, the customer acquisition cost. Could you please share with us maybe the quarterly trend of your average customer acquisition cost for each borrowers and for investors as well? Thank you.

Yes. I can take that, yes. So for funding sources actually during the Q3, our online lending platform continue to provide majority of our fundings, 80% plus of our fundings with the financial institutions provided less than 20% for our fundings. One of the key theme is, actually, we have a lot of financial institutions that we want to provide the funding to us. But actually, if you go to our APP everyday, you can see almost 80% to 90% of the time we have, nothing to sell. So basically, we recover very strongly from the turmoil period that the industry went through during the July and August. So, our investor continue to demonstrate strong confidence to our product. So, right now, honestly, is I think we have more appetite for our loan product then we will be able to supply at this moment. In the long run, I think, we will increase our institutional funding percentage. In the near-term, we just don’t have two many extra assets to supply to that, yes. Yes, the second question, maybe Simon or Kevin can address, yes.

Yes. With regard to our customer acquisition cost, we just found that the customer acquisition for – both for public sector – public side and our [indiscernible] management side, they are very stable. We expect that acquisition – during the acquisition cost of our credit side will be around RMB120 for new comps. And from the – that will be RMB330 for new comps. But, of course, I do- I think, we will have some increase from the [indiscernible] side customer acquisition cost, because previously – we actually do very little in our – for those type of campaigns, but now we are – we have to do some investments in that, for example, in NBA’s sponsorship and other [indiscernible] projects, yes. Michelle, I this be apt for your questions.

Yes. Thank you very much.

Okay. [Operator Instructions] Okay. Seeing no further questions in the queue, this concludes our question-and-answer session. I would like to turn the conference back over to Jennifer Zhang for any closing remarks.

Thank you, everyone, for joining us on the call today. If you haven’t got a chance to raise your question, we will be pleased to answer them through follow-up contacts. I look forward to speaking with your again in the near future. Thank you.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.