Futu - Earnings Call - Q3 2020

Transcript

Operator (participant)

Hello, ladies and gentlemen. Welcome to Futu Holdings' third quarter 2020 conference call. At this time, all participants are in a listen-only mode. After the management's prepared remarks, there will be a question-and-answer session. Today's conference call is being recorded. If you have any objections, you may disconnect at this time. I would now like to turn the conference over to your host for today's conference call, Mr. Daniel Yuan, Chief of Staff and Head of IR at Futu. Please go ahead, sir.

Daniel Yuan (Chief of Staff and Head of IR)

Thanks, Operator. Thank you for joining us today to discuss our third quarter 2020 earnings results. Joining me on the call today are Mr. Leaf Li, Chairman and Chief Executive Officer; Arthur Chen, Chief Financial Officer; and Robin Xu, Senior Vice President. As a reminder, today's call may include forward-looking statements which represent the company's beliefs regarding future events which, by their nature, are not certain and are outside of the company's control. Forward-looking statements involve risks and uncertainties. We caution you that a number of important factors could cause results to differ materially from those contained in any forward-looking statements. For more information about the potential risks and uncertainties, please refer to the company's filings with the SEC, including its registration statement. With that, I will now turn the call over to Leaf. Leaf will make his comments in Chinese, and I will translate.

[Foreign language]

Hello everyone. Thank you for joining the earnings call today. I am excited to share that we continue to deliver outstanding operating and financial results in the third quarter of 2020.

Leaf Li (Chairman and CEO)

[Foreign language]

Daniel Yuan (Chief of Staff and Head of IR)

Our net paying client addition was approximately 115,000, bringing the total number of paying clients to over 418,000, up 137% year-on-year. This marks our highest quarterly paying client addition. Our China mainland and Hong Kong paying clients both experienced triple-digit growth in the quarter, driven by a number of industry tailwinds, including continued market volatility and the surge of high-profile Hong Kong IPOs. Organic growth continued to contribute over half of our new paying clients. During our second quarter earnings call, we guided for 280,000 net new paying clients in 2020. We are well on track to deliver this guidance.

Leaf Li (Chairman and CEO)

[Foreign language]

Daniel Yuan (Chief of Staff and Head of IR)

Besides total paying clients, we also witnessed robust growth in total client assets. At the quarter end, total client assets reached HKD 201 billion, representing 178% growth on a year-on-year basis and 41% growth on a quarter-on-quarter basis. Average asset balance for paying client was HKD 481,000, up 17% year on year. Our quarterly paying client retention rate surpassed 98% for the seventh consecutive quarter.

Leaf Li (Chairman and CEO)

[Foreign language]

Daniel Yuan (Chief of Staff and Head of IR)

Total trading volume in the quarter surpassed the HKD 1 trillion landmark and exponential 381% year-on-year growth. U.S. stock trading contributed about 56% of the total trading volume. In the third quarter, we launched Hong Kong securities lending and several derivatives trading offerings, including Hong Kong stock futures and MSCI index futures. The market share of our derivatives trading products climbed meaningfully over the quarter. Going forward, we will seek to further diversify our derivatives trading offering.

Leaf Li (Chairman and CEO)

[Foreign language

Daniel Yuan (Chief of Staff and Head of IR)

The strong IPO market continued to play in our favor. In the third quarter, six IPOs recorded over HKD 10 billion subscription respectively on our platform, including the U.S. IPOs of XPeng Motors and Beike, and the Hong Kong IPOs of Nongfu Spring and Mingyuan Cloud. To note, the Hong Kong IPO of Nongfu Spring attracted over 110,000 retail investors to subscribe over HKD 35 billion on our platform.

Leaf Li (Chairman and CEO)

[Foreign language]

Daniel Yuan (Chief of Staff and Head of IR)

As for our wealth management business, Money Plus, we established partnerships with nine reputable asset managers, including Morgan Stanley, Invesco, and BNP Paribas. We have over 30 wealth management partners at the quarter-end. In the third quarter, wealth management daily average asset balance reached HKD 8.15 billion, a record high since we launched the service. Over 29,000 clients held mutual fund positions at the quarter end. In September, we launched bond trading for professional investors. We now offer a diverse array of USD-denominated bonds covering multiple industries, including technology, real estate, logistics, and finance. Money Plus is strategically positioned to offer more diversified products, catering to different risk appetites of our users and retaining more user assets within Futu's ecosystem.

Leaf Li (Chairman and CEO)

[Foreign language]

Daniel Yuan (Chief of Staff and Head of IR)

Our enterprise service Futu I&E also made solid progress in the quarter. We obtained ISO 27701 certification for our ESOP SaaS system, the world's highest level of privacy information system certification. We are the first ESOP SaaS provider in China to receive such recognition. At the quarter end, we had 126 ESOP clients and 81 IPO and IR clients. Futu I&E continues to be the go-to ESOP partner for industry-leading TMT, biotech, and consumer retail companies, including Miniso, Ocumension, and Jiumaojiu Group.

Leaf Li (Chairman and CEO)

[Foreign language]

Daniel Yuan (Chief of Staff and Head of IR)

We have been reaching new milestones with internationalization. Futu Singapore Private Limited was officially granted the capital market services license from the Monetary Authority of Singapore. We aim to launch the Singapore business in the first half of 2021, and we are excited about our growth prospects in the country. Besides, I am pleased to share that on November 13th, Futu Futures Inc.'s application for National Futures Association Member was approved. Futu Futures Inc is now a Commodity Futures Trading Commission registered futures commission merchant.

Leaf Li (Chairman and CEO)

[Foreign language]。

Daniel Yuan (Chief of Staff and Head of IR)

Next, I'd like to invite our CFO Arthur to discuss our financial performance.

Arthur Chen (CFO)

Thanks, Leaf and Daniel. We continue to deliver outstanding financial results. Let me walk you through some key of our financial details for the three quarter. All currencies are in HKD terms. We recorded total revenues of HKD 946 million, up 2.7x year-on-year and 38% Q-on-Q. To break it down, brokerage commission and handling charge income was HKD 563 million, up 3.6x year-on-year and 38% Q-on-Q. This was primarily due to the 3.8x growth of our total trading volume. Our blended commission rate this quarter was 5.8 basis points, down from 6.6 basis points in the last quarter. This sequential decrease was primarily due to the increase in trading volume per dollar for clients that used the flat rate pricing package option we offered. Brokerage income accounts for 60% of our total revenue in the quarter.

Interest income was $276 million, an increase of 140% year-on-year and 33% Q-on-Q. Both margin financing interest income and IPO financing interest income achieved a strong growth. Margin financing interest income increased primarily on the back of a significant 142% year-on-year increase in daily average margin financing balance. IPO financing interest income increased significantly due to the heat Hong Kong IPO market and our clients' increasing appetite to subscribe high-quality IPOs on margin. Interest income contributes about 29% of our total revenue. Other income was $107 million, up $5.6 million year-on-year and 52% Q-on-Q. The growth was primarily due to increase in our IPO subscription service charge income, currency exchange service income, and underwriting fee income. Other income contributes about 11% of our total revenue.

On the cost side, total cost was $182 million, up 161% year-on year-and 18% Q-on-Q. To break it down, brokerage commission and handling charge expenses were $101 million, an increase of 3.1x year-on-year and 31% Q-on-Q. The growth was roughly in line with our total trading volume growth. Interest expenses were $47 million, an increase of 151% year-on-year and 18% Q-on-Q, primarily due to higher IPO financing interest expenses. Processing and servicing costs were $34 million, an increase of 27% year-on-year, primarily due to increase in cloud service fee to support the growing number of trades. As a result, total gross profit increased to $764 million, up 3.1x year-on-year and 43% Q-on-Q. Gross margin was expanded to 81% versus 73% in the same period last year.

Total operating expenses were HKD 323 million, an increase of 111% year-on-year and 22% Q-on-Q. To break it down, R&D expenses were HKD 150 million, an increase of 111% year-on-year and 28% Q-on-Q. The increase was primarily due to increase in R&D headcount to support our business expansion. Selling and marketing expenses were HKD 111 million, an increase of 184% year-on-year and 15% Q-on-Q. The increase was primarily due to higher branding and marketing spending. Although we are more aggressive on our marketing strategy to take advantage of the favorable market condition, our client acquisition costs per each unit continue to trend down in this quarter. G&A expenses were HKD 62 million, an increase of 45% year-on-year and 22% Q-on-Q. The increase was primarily due to increasing headcount for G&A personnel.

As a result, our net income increased to $402 million. Non-GAAP adjusted net income increased to $408 million, up over 16x year-on-year and 68% Q-on-Q. The significant bottom line growth was primarily due to robust revenue growth and strong operating leverage. Also, in this quarter, we completed our $314 million U.S. equity follow-on financing. This placement has doubled our equity base and significantly strengthened our balance sheet to support our future growth. That concludes our prepared remarks. We now like to open the call to questions. Operator, please go ahead.

Operator (participant)

Thank you, sir. Ladies and gentlemen, we will now begin the question-and-answer session. If you wish to ask a question, please press Star followed by the number one on your telephone keypad and kindly wait for your name to be announced. Once again, it is Star followed by one to ask a question. If you wish to cancel your request, you can press the Pound or Hash key. We have the first question coming from the line of Ivy Liu from HSBC. Please go ahead.

Ivy Liu (Analyst)

Thank you. It's Ivy Liu from HSBC, and I have two questions today, mainly on the financial numbers. The first one is in the balance sheet, the loans in advance. Also, we've seen a very big difference between this number and our margin balance. Could management explain the reason of this discrepancy? The second number is on the short-term borrowings because we see a sharp increase on this number. Could management give us guidance on the source of that funding and also the funding cost trend going forward? Thank you.

Arthur Chen (CFO)

Okay. Thank you, Ivy. I will answer your second question first. For the short-term borrowing, actually, since the beginning of this year, we start to further optimize our funding source. Besides the equity following and also the bank borrowing, we also start to use the equity repo to further lower down our financial cost and further to support our balance sheet growth. The items you can see from the short borrowing are more due to this equity repo instrument. For the first question, I think basically these two things, the loan balance and also the margin balance, are still quite in line. Actually, I see the number is not too far away. Could you further clarify your questions?

Daniel Yuan (Chief of Staff and Head of IR)

Hi, Ivy. Maybe I'll chime in a little bit on your first question regarding the discrepancy. I just want to clarify. For our margin financing and securities lending balance, that number does not include our IPO financing balance. For the line item loans and advances, that includes our IPO financing balances. Actually, in the third quarter, there are two IPOs that extended from September to October. If I remember correctly, Yunding Xinyao and Zhao Hui Sheng were the two Hong Kong IPOs that started the IPO subscription process in September, but they eventually got listed in October. That is about HKD 25 billion of IPO financing included in our loans and advances balance on the balance sheet, whereas it is not included in the margin financing and securities lending balance. I think that kind of explains the discrepancy here.

Operator (participant)

Thank you. We have the next question. This is coming from the line of Daphne Poon from Citigroup. Please go ahead.

Daphne Poon (Analyst)

Hi. Good evening, Management. Thanks for taking my questions. My first question is regarding the IPO subscription business. Just wondering if you can help break down the contribution in this quarter to the interest income, other revenue, and commission. Related to that is that recently we saw the news from Hong Kong Stock Exchange saying that they're planning to revise this IPO subscription rule to basically shorten the subscription period from T+5 to T+1. Just wondering if the management has done any activity or estimate in terms of the revenue or earnings impact from this. Second, just want to quickly check on the new paying customer mix this quarter between the Hong Kong and China clients. Lastly is regarding your sales and marketing costs. As you mentioned earlier, the unit customer acquisition cost per new paying client is down meaningfully.

I think now it is less than HKD 1,000. Just wondering if that will be the sustainable level going forward. Basically, what is the outlook here? Thank you.

Arthur Chen (CFO)

Okay. Thank you, Daphne. I will answer your first question about IPO margin, and I will partially answer your second question in terms of breakdown of new paying clients. I will leave the acquisition cost outlook to my colleague, Robin. We noticed this consultation paper issued by Hong Kong Stock Exchange early this week. You are right that the IPO processing timeline may be cut from the current T+5 days to T+1 days under this new arrangement. On a static perspective, our IPO margin revenue will be negatively impacted, similar to all our retail broker peers. I expect we may lose middle single-digit revenues if we implement this new policy in the first three quarters of this year. On a forward-looking perspective, I think this loss may be significantly offset by the demand increase and also the industry consolidation within the retail brokerage business in Hong Kong.

Despite our near-term financial loss, which I think is fully manageable, we strongly support this initiative advocated by the Hong Kong Stock Exchange as we think this reform will improve the overall market efficiency and eliminate unnecessary transition costs for all market participants. This will make the overall market more accessible to the main street. We think every participant, including Futu, will be better off eventually. For your second question, in terms of the new paying clients we achieved in this quarter, 53% came from the Hong Kong local market and the remaining 47% came from the mainland. I will leave the client acquisition cost questions to Robin. Thank you.

Daniel Yuan (Chief of Staff and Head of IR)

Thank you. Robin, your question is [Foreign language]

Robin Xu (SVP)

[Foreign language]

Daniel Yuan (Chief of Staff and Head of IR)

All right. This year, the percentage of our new paying clients from organic growth continued to climb meaningfully quarter after quarter. You can see that our per paying client acquisition cost has therefore come down quite a bit this year. In terms of our overall market spending, I think we attach more importance to the ROI, our client acquisition, as opposed to the total marketing expenses.

Operator (participant)

Thank you. Shall we move to the next question? We have the next question coming from the line of Yiran Zhong from Greenwoods.

Yiran Zhong (Analyst)

Thanks for taking my questions and congratulations on a strong quarter. I have three questions. One is, in 3Q, you have further gained trading volume market shares both in Hong Kong and US. How is the trend looking for 4Q thus far? Also, more specifically on US volume, we noticed that the China ADRs trading volume had significantly picked up in November. Could you share any color on kind of the stock distribution of your US volume? What are the top-traded US stocks on your platform and how concentrated on the China ADRs traded through Futu? Secondly, we calculated that the overall commission and handling fee rate was 5.5 basis points in 3Q, lower than the 6.4 basis points in the last quarter. Could you share kind of the underlying drivers for the Q-on-Q change? Any color on how it's trending going forward?

Thirdly, on customer acquisition, are you able to break out the contribution from, say, IPO-related promotional events? Just trying to understand how should we think about the customer acquisition growth related to IPOs? Also, how should we think about the trend going beyond Q4, beyond this year, into next year and beyond? Thank you.

Arthur Chen (CFO)

Okay. Thank you. I will answer the first two questions, and I will also leave the third question to Robin for your inquiries about client acquisitions. Number one, as we mentioned in our last earning calls, we see significant spikes in terms of our market share gains in Hong Kong since July. The situation in Q3, you can see overall our Hong Kong trading volumes increased a lot. In terms of the market shares, we continually keep our market shares over 2%. I think the situation in October is still well on track. I do expect there can be some structural positive things going forward. In terms of the U.S. trading volume, actually, I think the breakdown for our US trading is not very concentrated on these Chinese ADR names.

If my memory is right, our Chinese ADR trading volume accounts for roughly 10%-15% of our total U.S. trading volumes overall. Despite we were benefit from these Chinese ADR trading volumes recently in the U.S., I think the overall impact is not very meaningful. Secondly, about your question on the commission rate, actually, I addressed this in the opening remarks. On a like-for-like basis, actually, our commission rate keeps very stable. You can see our blended commission rate dropped down this quarter compared with last quarter. This is mainly due to the increase in trading volume per dollar for clients who use the flat rate pricing package options we offered. I will leave the third question to Robin.

Daniel Yuan (Chief of Staff and Head of IR)

Okay. I'll take the third question on our paying client breakdown. It's very difficult for us to break out what clients specifically come for the IPOs because it's really hard to trace their activities. They may invest in stocks first and then subscribe to IPOs. It's very hard to do that breakdown. Overall, we have seen that when these jumbo IPOs get listed in Hong Kong, we see a pickup in our client acquisition for one to two weeks beforehand. For Ant Group's IPO, for example, two weeks before the Ant Group's IPO, we have seen a meaningful pickup in our paying client numbers. As we mentioned, these jumbo deals in Hong Kong will definitely be a positive contributor to our paying client growth. Again, it's very hard to break down the specific percentage.

We think the Hong Kong IPO, in general, just attracts a lot more attention to the market. It may bring some clients that are interested in the IPO at first, but then they will be converted to other trading clients. Overall, we have not seen a meaningful change in our client's asset balance or their trading behaviors.

Operator (participant)

Thank you. Once again, ladies and gentlemen, it is Star followed by one to ask a question. We have the next question from the line of Robin Xu from Evalueserve. Please go ahead. Quinn Yu, your line is open. Please go ahead.

Kelvin Chu (Analyst)

It's Kelvin Chu from UBS. This is me. Thank you for taking my questions. Two questions for me. First, you have delivered very strong brokerage business this year with decent market share gains. At this point, what is your long-term strategic vision for your business model? How do you prioritize your transitional business versus wealth management fund product distribution over the long-term? Secondly, can we have an update on the US settlement system? Any disruption due to COVID-19? Just in terms of timing, when should we expect the migration of the trading accounts to take place? When will the financial impact come through in terms of potentially higher interest income from settlement cash? Thank you.

Arthur Chen (CFO)

Okay. Thank you, Kevin. Let me answer your second question first. I will leave the first question to my colleagues, Leaf and Robin. You are right. Our progress in the US self-clearing was negatively impacted by this COVID-19 pandemic. Now, we currently expect we will start the trial migrations to our self-clearing house in the first half next year. It is still too early to expect the financial impact. I think, overall speaking, next year's financial impact will still not be too significant. Just to give you a rough idea, based on our current U.S. stock positions, if we complete this full process of the self-clearings, I think we will at least generate additional $50 million U.S. operating profit.

Robin Xu (SVP)

[Foreign language]

Daniel Yuan (Chief of Staff and Head of IR)

Our strategy is composed of five different elements to our businesses. Number one is our retail brokerage business. Number two, our management business that provides a lot more earnings visibility by nature. Thirdly is our enterprise service, Futu I&E, with our ESOP system and IPO distribution services. Number four is our international expansion. We want to expand our client side, and we think that overseas market will contribute to a meaningful share of our overall paying client base in the mid to long run. Number five is that we want to create a Futu intergrated ecosystem that is centered around users and provides connectivity to different stakeholders like the investors, KOLs, media, etc. We want to construct a self-reinforcing ecosystem.

With regards to the relationship between our brokerage and wealth management business, I think our strategy is to become a one-stop financial services platform for our clients and catering to the various different asset allocation needs for our clients. I think wealth management was a very important step towards the strategy.

Operator (participant)

Thank you. We have our next question. This is coming from the line of Hanyang Wang from 86Research. Please go ahead.

Hanyang Wang (Equity Research Analyst)

Good evening, Management. Thank you for taking my questions. My first question is about our margin financing business. Our successful settlement offering last quarter helped us serve more margin financing demand and significantly improved the margin financing balance. Will the impressive growth be sustainable given we have the leverage restriction on the business in Hong Kong? How shall we project the future growth of our margin financing balance? Do we need to keep raising money from the capital market to meet the leverage requirement? My second question is on our user acquisition strategy. In the third quarter, I think a number of Hong Kong paying users had surpassed the main users. What will be our strategy in the future to acquire the main China users, which seems to have a larger user base that we could explore into?

My final question is about the Ant IPO suspension. Will there be any impact on our IPO financing business in the fourth quarter? Thank you.

Arthur Chen (CFO)

Okay. Thank you. I think I have already answered your third question before through another analyst. I will answer your first question about the margin financing, and I will leave the user acquisition strategies to my colleagues, Robin and Daniel. For the margin financing, you are right. After the equity placement we did in the third quarter, our qquity base has already almost doubled. This will be very supportive for our balance sheet business going forward. I think based on our current business expansions, we will have sufficient monies to support our margin financing in the next 12-18 months. Also, if you look at our third quarter number, our total equity base now is already exceeding HKD 5 million. Based on the regulations made by Hong Kong SFC, each retail broker's leverage ratios in Hong Kong cannot exceed five times.

You can just hear just to give you some rough ideas about the further upside for our margin businesses. I think it is very difficult to estimate the margin balance out of going forward as there was a lot of market conditions. Market volatilities will impact the client's risk appetite. I think long-term speaking, as we have more and more clients, this balance will continue to grow down the road. Now, I will leave the second question to Robin. Thank you.

Robin Xu (SVP)

[Foreign language]

Daniel Yuan (Chief of Staff and Head of IR)

We have been quite aggressive with our Hong Kong marketing strategy, and that turned out to be quite effective because Hong Kong itself is a small place, and the existing client base, they are very prone to trading Hong Kong and U.S. securities already. Our marketing efforts have been quite effective so far. With regards to our mainland client acquisition, I think we use different client acquisition strategies because of a number of constraints. For example, ESOP continues to contribute a very steady stream of high-quality clients, and word-of-mouth referral is more meaningful in mainland than in Hong Kong in terms of our absolute paying client contribution. We have different client acquisition strategies for mainland, and we think the growth prospects in mainland are very strong. Thank you.

Hanyang Wang (Equity Research Analyst)

Thank you. Very helpful.

Operator (participant)

Thank you. We have our next question. This is coming from the line of Cecilia Xu. from DTC Investment. Please go ahead.

Cecilia Xu (Analyst)

Hi, Management. Thank you for taking my question and really congrats on the strong quarter. I'm really excited about Futu launching Hong Kong option products and other derivatives instruments so as to expand our product portfolio. My concerns are on the risk control side. I don't know if you have anything to share at this moment about risk management regarding your burgeoning derivatives business segment. Thank you.

Arthur Chen (CFO)

Okay. Thank you. I will let my colleague, Daniel, answer this question. Thank you.

Daniel Yuan (Chief of Staff and Head of IR)

With regards to our risk management procedures, we have always been quite prudent with our risk management approach. Actually, if you compare our LTV ratio, I mean, for individual stock margin financing, if you compare our LTV ratio to those offered by traditional banks, we are more conservative around that. That also goes with our derivatives trading risk management as well. I think to prepare for the launching of this business, we have actually recruited a number of finance personnel from the traditional institutions that have very rich experience in risk management for derivatives products. Overall, we have been prudent in our approach, and we gradually roll out our derivatives trading products. Like we mentioned, in the third quarter, we started offering the Hong Kong securities lending business.

So far, we've only opened up that service to 10% of our total paying client base, and we decided to open it to 100% of our client base by the end of this year. When we start the new derivatives products, we are prudent, and we take a gradual approach towards our business development. Overall, I think so far, we have not, since we launched the margin financing business in 2017, and we have added a lot of new derivatives products. So far, we have not experienced any material loss on any of our margin financing or derivatives trading offering. Thank you.

Cecilia Xu (Analyst)

Understood. May I ask one more question on your brokerage fee and commission expense ratio? Is there a meaningful difference between the brokerage expense ratio of your U.S. trading volume and that of Hong Kong volume? How should we expect the expense ratio to be in, say, three to five years when your proprietary U.S. stock clearing system is fully developed? Thanks.

Arthur Chen (CFO)

I think in terms of the blended commission rate in Hong Kong and in the U.S., U.S. rate is slightly higher than Hong Kong, but the difference is not too significant. Secondly, for the U.S. self-clearing capabilities, Kevin from UBS also raised this question before. I think it will take a very long time for us to gradually migrate our clients' U.S. stock positions to our self-clearing house as it has a lot of the technology know-how. We need to make sure all of these corporate actions can be conducted in a right manner. It definitely will take time.

Just to give you a rough idea, if we migrate all of these existing positions to our self-clearing house today, the cost savings in terms of the execution fee and also the idle cash potentially we can monetize alongside with the stock positions, we can potentially monetize through stock borrowing and the lending activities. We can generate additional $15 million U.S. operating profit without considering any direct people costs nowadays.

Cecilia Xu (Analyst)

Got it. Got it. That's really helpful. Thank you.

Arthur Chen (CFO)

Thank you.

Operator (participant)

Thank you. Once again, ladies and gentlemen, just to remind you, it is Star followed by the number one to ask a question. Once again, it is Star one to ask a question. Pardon me, ma'am. We do not have any questions at this moment. I would like to hand the conference back to our host. Daniel, please take over for any closing remarks.

Daniel Yuan (Chief of Staff and Head of IR)

Thank you. That concludes our call today. On behalf of the Futu Management Team, I would like to thank you for joining us today. If you have any further questions, please do not hesitate to contact me or any of our Investor Relations representatives. Thank you and goodbye.

Operator (participant)

Thank you, sir. Ladies and gentlemen, that concludes our conference for today. Thank you all for your participation. You may disconnect your lines now. Thank you to all.