Qfin Holdings - Q2 2019

Transcript

Operator (participant)

Hello and welcome to the conference call entitled 360 Finance Announces Second Quarter 2019 Unaudited Financial Results. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero on your telephone keypad. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Matthew Li of 360 Finance. Please go ahead.

Matthew Li (Director of Investor Relations)

Thank you. Operator. Hello everyone and welcome to our second quarter 2019 earnings conference call. Our results were issued earlier today and can be found on our IR website. Joining me today on the call are Mr. Haisheng Wu, our CEO and Director, Mr. Alex Xu, our CFO, and Mr. Yan Zheng, our Vice President. Before we begin our prepared remarks, I would like to remind you of the company's Safe Harbor statements in connection with today's conference call. Except for any historical information concerning the material discussed on this conference call may contain forward-looking statements.

These statements are based on our current plans, estimates and projections, and therefore you should not place undue reliance on them. Forward-looking statements involve inherent risks and uncertainties. We caution that a number of important factors could cause actual results to differ materially from those contained in any forward-looking statement. For more information about potential risks and uncertainties, please refer to the company's filings with the SEC in its registration statement. In addition, this call will also include discussions of certain non-GAAP financial measures. Please refer to our earnings release, which contains a reconciliation of the 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. With that, I will turn the call over to our CEO, Mr. Wu. Please begin.

Haisheng Wu (CEO and Director)

Okay, thanks, Matt. Thank you everyone for joining our call today. This is Haisheng Wu and we are sorry that Mr. Jun Xu is not able to join us today since he has to leave the company for personal and family reasons. We would like to thank him for his extraordinary services to 360 Finance. As the Co-founder and the CEO, our business fundamentals are very strong. We will continue to execute our strategy to building our company into a financial technology company. Our core team members have been working together very well and we expect the transition process will be very smooth. We believe our advantages are structural and systematic. We have established a solid foundation for our business in China. We believe our structural advantage will not be impacted by the change of one management member.

Now, I will go back to my prepared remarks. We are pleased to further solidify our leading position in industry with another solid quarter. As of June 30, 2019, we have cumulatively originated RMB 217 billion of loans through our platform with outstanding loan balance of RMB 51.3 billion. Our cumulatively registered users reached 109 million users, with credit line reached 19.2 million, and the cumulative borrowers with successful drawdown reached 12.5 million. We are very proud of building such a huge user base and business in just three short years since we founded the company. In the second quarter we acquired 14.2 million registered users, granted credit line to 3.2 million borrowers and had 2.1 million borrowers and with successful drawdown, our loan origination volume increased by 127% year-over-year and 17% from the previous quarters to RMB 48.1 billion.

While we continue to grow our business quickly and consistently, we have been able to efficiently manage our borrower credit risk. Our market's leading risk management capabilities is well recognized by our institutional funding partners. It has enabled us to obtain sufficient institutional funding at competitive rates and offer more affordable credit products to our users. As of June 30, we have established partnership with 62 financial institutions. We believe this achievement strongly demonstrates our leading position in terms of scale growth and risk management. Our strong business development is primarily driven by our expanding user base and continuous investment in advanced technologies such as big data and artificial intelligence. We have also vigorously invested in brand promotion and user acquisition to quickly build up a huge user base. In less than three years we have been able to acquire more than 100 million registered users.

We firmly believe that our spending on user acquisition is a long term investment for revenue and profit generation in the future. We have clearly demonstrated that we can continue to benefit from our proactive user acquisition strategy in the long run since the earnings from borrower's first drawdown and enough to cover the latest acquisition cost. Leveraging our user acquisition system that is driven by big data, we are working with nearly 100 third-party channels to acquire higher quality users. Through the application of machine learning techniques, we are able to assess the borrower's credit profile and readiness to borrow, which helps us achieve more precise user targeting and improve our overall user acquisition capabilities. In the second quarter, we stopped investing in some channels that sourced lower quality borrowers and improved our overall user quality and acquisition efficiency.

We also launched several new acquisition initiatives in the quarter, for example, we made a strategic investment in a social e-commerce platform with strong growth momentum. We also established an offline sales force to promote our products and services to customers. We will further diversify our user acquisition channels in the future. As I mentioned earlier, we have established a huge user base of 109 million registered users. We have only served 12.5 million of them with our existing products and services. This tells us that we still have huge opportunities to tap into our existing user base and increase conversions. We will further address the various needs of our huge user base by providing them with more diversified products and services.

In addition to our strong presence in the domestic market, we are actively exploring opportunities to extend our FinTech services to select international market in Southeast Asia and South Asia. Our firm commitment to investing in big data and artificial intelligence has enabled us to aggregate a massive amount of data and build extremely strong data processing capabilities. For example, our social network system covers 2 billion and 19.2 billion relations that we are able to refresh our system every three seconds and analyze 1.5 TB of data on daily basis. Meanwhile, we have made significant progress on data mining and the risk modeling. For each applicant, we collect more than 4,000 basic variables from which more than 100,000 variables are derived and 200 subscores are calculated by our pre-trained machine learning model.

With these variables and subscores, our entire decision tree is now composed of over 10,000 branches. It is built to perform a dedicated risk evaluation, and each applicant can be allocated with the most appropriate credit and pricing. By applying cutting-edge AI technologies, we have really set ourselves apart with our industry-leading risk management and it has helped us ensure higher asset quality. In addition, we have deployed AI robots in various operational functions to improve the standardization of our operations and reduced operational risk and labor cost. As of June this year, 75% of our collection work, 77% of our telemarketing work and 91% of customer service work have been performed by our AI robots. The remaining work of collection, marketing and customer service is performed by humans, though we actually use AI robots there as well for quality inspection.

So you can see we have made great efforts in technology and research this year. As of June 30, we had submitted applications for 139 patents for our financial technologies. We will also join hands with Shanghai Jiao Tong University to establish a lab to study the most cutting-edge AI algorithms for applications in our risk management and marketing management strategies, which will further strengthen our team's technical capabilities. Based on our strong technology capabilities, we will focus more on providing technology services to our partners. They have significantly increased our loan origination under capital-light model for our institutional funding partners. We expect this trend to continue in the coming quarters. With that, I will turn the call over to our CFO Alex to discuss our financial results.

Alex Xu (CFO)

Thank you, Haisheng. Since our operational and financial results were released earlier today, I will only comment on a few highlights. Our Q2 financial results continue to be very solid as our total net revenues increased by 128% year-over-year and 11% from the previous quarter to RMB 2.2 billion. This brings our total net revenues in the first six months of this year to RMB 4.2 billion, which means that we have already accomplished that 50% of our full year revenue guidance of RMB 8 billion-RMB 8.5 billion. The momentum is very strong in the foreseeable future and we remain very confident in achieving our full-year results provided in our guidance. In addition to driving the steady growth of our business, we are also optimizing the mix of loan facilities under different models.

During the second quarter, we originated RMB 3.8 billion of loans under a capital-light model which brings zero credit risk to our company. Loans originated under the capital-light model accounted for approximately 8% of the total loan origination during the second quarter, which is significantly higher than less than 1% in the previous quarter. We expect this trend will continue as we focus on providing technology services to our institutional funding partners. In the second quarter, we also originated RMB 3.5 billion on-balance sheet loans through Consolidated Trust which increased by 70% from previous quarter and accounted for 7.5% of loan origination volume in Q2. The off-balance sheet loans generate financing income and better match revenue recognition with cash flow. As we are seeing a decline in channel funding costs from trust, we plan to originate more on-balance sheet loans through Consolidated Trust in the coming few quarters.

While most of the cost items are largely in line with the growth of our business, I would like to reinstate our view on sales and marketing expenses in order to sustain our growth in the long run. We continue to invest vigorously in brand promotion and customer acquisition. As Haisheng just mentioned, we strongly believe that the user acquisition is a long term investment instead of a short term expense. In the second quarter our sales and marketing expense were RMB 839 million. Despite the increase of our user acquisition cost due to competitive market conditions, the return on investment of our borrowers remain attractive. Based on our calculations, the earnings from the borrowers first drawdown are enough to cover all the costs and on a daily basis. We closely monitor this parameter to drive our customer acquisition business.

Coming to the balance sheet at the end of Q2, we have a total cash of RMB 4.2 billion, including cash and cash equivalents. Restricted cash and security deposit prepaid to third-party guarantee companies. Our total cash increased by 49% from the end of June 2018 and 25% from the first quarter. Our strong operating performance is well recognized by renowned financial institutions, and we were able to obtain short-term loans of RMB 1.4 billion in the second quarter to further enhance our working capital. We believe we have a very strong cash position to support our business growth and daily operations. Finally, I would like to mention a little bit about our upsized public filing public offering of more than 11 million ADS in late June. All the ADS sold were secondary shares from several of our early-stage financial investors.

We would like to thank the selling shareholders for their sought support in the past and we sincerely welcome the new investors. Investors, the fundamentals of our company are very strong and we are confident that we are able to create sustainable value for all the shareholders in the future. With that, I will conclude our prepared remarks and open the floor for questions. Thank you.

Operator (participant)

We will now begin the question-and-answer session. To ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. Once again it is star then one to ask a question. At this time we will pause momentarily to assemble our roster. The first question comes from John Cai of Morgan Stanley. Please go ahead.

John Cai (VP)

Hi, thank you, management for taking my questions and congratulations on the continued strong growth momentum for this quarter. So my first question is about the capital-light model. Can the management share more details on the economics of this capital-light model as compared to our traditional funding models? And also what portion or percentage do we see this capital-light funding trend in the future? For example, towards the end of the year, what percentage of the loan facilitation would come from this capital-light model? And my second question is about the cash. I think I'm looking at the free cash of RMB 1.8 billion there. So it's increased on a year-on-year basis. Sorry, on a quarter-on-quarter basis. I think as our loan book continue to grow, obviously our cash flow on a monthly basis will continue to increase.

So just wonder what we see in this free cash trend in particular, given we have some plan to invest in the international market. And the final question is about a cost. So I think actually I have two questions, two more questions. The first one is about the origination cost. It seems it's increased on a Q-on-Q basis. Just wonder if there's more color on that. And the final one is about the delinquency rate. It edged up a little bit to. 1% for the 90 days delinquency. If there's any colors on that, it would be great as well. Thank you very much.

Alex Xu (CFO)

Okay, thank you, John. Let me answer your first three questions. I will turn the last question to our CRO talking about the delinquency rate. Okay, so for the capital-light model, it's essentially just we don't take any credit risk. We just transfer all the economics to the financial institutions, our partners. The economics will be a little bit lower compared with the traditional model facilitation model obviously. But it's manageable for us, and we think that it will help us to build up a healthy, more healthy loan book in the long run. In terms of percentage, as I just mentioned, we see 8% loan origination in the last quarter and the percentage will continue to go up. It really depends on the interaction between the customers, financial institution partners and our risk model.

We can't give a specific number, but we were very confident to see that percentage go up to double digits, more double digits by the end of this year. So that's the first question. The second one for the cash. I think that you are correct that this cash position is highly correlated with our business model. So, given that we see our business very solid in the coming few quarters, the cash position will continue to go up. And for the third question, the origination, the key reason is we increased the on-balance sheet loan. The financing cost for the on-balance sheet loan will be recorded under that item. So it increased a little bit more.

So that means that if we continue to increase on balance sheet loans, these so-called origination and servicing fee will continue to go up. But that's primarily driven by the on-balance sheet loans financing cost. That's the third question. So for the last question, let me just turn to our CRO.

Speaker 8

[Foreign language]

Matthew Li (Director of Investor Relations)

Hey John, this is Matthew. I have translated for Mr. John. So, although we see a slight increase of our M3+ delinquency ratio in the second quarter to 1.02%. So we believe this is still, you know, an industry-leading level if you compare with other players. So we think when we look at our risk performance of our loans by vintage, the numbers make more sense. So if you look at the vintage performance of our M6 delinquency rate, we also included that in our earnings release. So the loans we facilitated in the recent quarters are actually performing better than the ones we facilitated in Q2 of last year. So we're seeing an improving trend of our risk management.

Alex Xu (CFO)

John, I hope all this answers your questions.

John Cai (VP)

Yes, it's very helpful. Thank you and congratulations.

Alex Xu (CFO)

Thank you.

Operator (participant)

The next question comes from Steven Chan of Haitong International. Please go ahead.

Steven Chan (Senior Dealer)

Good evening, management. This is Steven Chan of Haitong. Three questions for me. First of all, if my calculation is correct, I think that your take rate for the traditional loan facilitation business has been declining in Q2 compared to Q1. And I would like to know what's the rationale behind? Is that because of higher guarantee costs, lower lending rate or higher funding cost? So that's my first question. Second question, going back to the capital light model, you mentioned that you're targeting double digit towards the end of the year. Do you have any sort of like medium term target for this capital light model? And I would also like to know whether. Because I suppose this should be some gray area from the regulators because the regulators may not even encourage microfinance company to issue ABS or whatever.

So I'm not sure how large these proportion could grow. So could you give us a medium term target, say three to five years time? What's the proportion you're expecting that to reach? And finally about the acquisition cost, my rough calculation is that it has increased further from Q1 around RMB 200 now to around RMB 260 if my calculation is correct. So I just want to know how much more you can afford to rise on these acquisition customer acquisition costs. So basically these three questions.

Alex Xu (CFO)

Thank you, Stephen, very good questions. Let me just answer first and see if you will have any further points to add for the take rate. You are correct. If you just use a lump sum number to calculate the take rate, the gross takeaway will decrease a little bit in the second quarter. The key reason is not because of the guarantee liability or the cost. That's because what I just mentioned we originate, we have used this capital-light model to, you know, that will decrease the economics a little bit. But we are more, the whole book is healthier. So if you take that capital-light model out, the traditional model take rate is relatively stable. Okay. And actually it's slightly going up a little bit to answer your question. Second question, first of all capital-light model is not ABS.

Okay.It's just, it's a pure for us is a pure technology service. We basically help the financial institution to find customers, do the preliminary risk analysis and help them do the post-origination collections and other services. The only difference between capital-light model and the traditional model is we don't take any credit risk and the financial institution will take all the credit risk. Okay, so it's not ABS issuance. So we don't see any regulatory hurdle for that portion. So going forward in the long run, we don't have a number yet, but we are very confident we increase that portion significantly as long as the financial institution are willing to take that. For the third question, acquisition cost. Yes, it continues to grow up. As I just in my remark, I just mentioned that that's primarily due to the competition landscape.

We still see that as a long-term investment and as long as the return on investment for the customers are sound and attractive, we will continue to do that. As I just mentioned, for the first long drawdown we can easily break even for all the cost. We don't see any reason to stop this long-term investment. Maybe Haisheng has something to add on the previous questions.

Haisheng Wu (CEO and Director)

Okay, I need to speak Chinese. I'm sorry. [Foreign language]

Steven Chan (Senior Dealer)

Can I have two follow-ups on that? Yeah. First of all

Alex Xu (CFO)

Stephen?

Steven Chan (Senior Dealer)

Yeah, sorry.

Matthew Li (Director of Investor Relations)

Let me finish the translation first. So as Alex mentioned, so. Under our current customer acquisition cost, we're still able to cover the borrower's acquisition cost at the initial drawdown of balloons, and our repeat borrower contribution keeps increasing in this quarter. So we believe the ROI, the return on investments of our sales and marketing expenses, is still very attractive and we think it worth long term investment. Currently, we have very sufficient funding from many of our institutional funding partners. We continue to see very strong demand from our users, from our borrowers. At the same time we have been performing very solid risk management of our assets. So that's why we believe the spending on sales and marketing is a long term investment instead of a short term expense. In terms of numbers, our CEO Haisheng mentioned our large user base earlier.

Even we stop spending for new customer acquisitions and focus on our existing users, our loan transaction volume will still be very large. So in Q2, our total loan facilitation volume was RMB 48.4 billion and our repeated borrower contribution was about 70% which translates to RMB 33.8 billion loans. So as you can see, as our repeated borrower contribution continued to increase, we'll still be able to achieve a very large transaction volume. So that's why we're focusing more on the future benefits instead of the short-term income or revenues.

Steven Chan (Senior Dealer)

Thank you. Can I have two more follow-up questions on the previous question?

Alex Xu (CFO)

Yes, sure, sure. Please go ahead.

Steven Chan (Senior Dealer)

Yes, first of all, I think I mix up the capital-light with the on-balance-sheet. So indeed my question should be for the ABS or trust scheme should be more related to the on-balance-sheet because we are seeing a very substantial rise in the on-balance-sheet loans. So how much larger are we foreseeing for that part to grow in the coming years? And second follow-up question is I think a lot of the. I met a lot of investors, they have big concern about the capital-light return. So could you give us some guidance about the say for example, maybe if you use the take rate, the take rate of the capital-light model compared to the traditional model. So how much lower? Just a rough idea. How much lower would that be?

Alex Xu (CFO)

Yeah, sure. So for the on-balance sheet, as I said, it's basically, it's primarily accounting treatment. Okay. Structure-wise it's the same as, you know, so there is no. If, if there is some hurdle from regulation on this business, there will be a hurdle on the off-balance sheet loan as well. It doesn't really matter. Okay. For the second question, the take rate, given that we didn't publish all these details, I can't give you the exact numbers but it really depends on the assets we offload. For example, if we offload the asset with APR 36, that means the difference of the take rate will be very large. But compared with if we offload the assets with APR a little bit lower to say for example 24%, then the take rate difference would be quite small. Hope I answer part of your questions, Steven?

Steven Chan (Senior Dealer)

So you mean that's the take rate for the capital-light model?

Alex Xu (CFO)

Yes.

Steven Chan (Senior Dealer)

Okay, thanks.

Alex Xu (CFO)

It's basically just the model is you use the APR, just take a percentage of the APR as our technology services fee. That's it. Then we don't deduct any credit cost. We don't deduct any financing cost. Okay.

Steven Chan (Senior Dealer)

Okay. Thanks.

Operator (participant)

Once again, if you have a question, please press star then oe on a touch-tone phone. The next question comes from Alex Ye of UBS. Please go ahead.

Alex Ye (Equity Research Analyst)

Hi, good evening, management. Thanks for taking my question. So I also have a follow-up on your capital-light models. So I wonder in terms of the partners that have utilized this model with you, I wonder what types of those partners are. So are they like the regional banks or national banks? And what is your cooperation with them like? So does it take a long time of relationship between you and the funding partners before they are more comfortable to do this capital-light model with you?

And also, are there any particular type of APR range that they are more comfortable to take on when they do this model? So that's my first question, and my second question is, can I get an update on your average APR on your total loan facilitation in the past quarter? Has it changed much from the around? 50% from the last quarter. Thank you.

Alex Xu (CFO)

Thank you. Alex, a very good question for the capital-light. The partners are, to be honest, are all long-term partners. They know our asset, they know our operation, they know our risk analysis capability. So that includes all these regional banks, consumer finance companies and even national banks. In terms of what kind of assets we offload to them, it really depends on the commercial discussion and negotiation. So as of today, we primarily offload high APR assets to the financial institution partners.

And to be honest, this model is not new. We did that last year. We did that in the first quarter as well. But we just wanted to highlight that for the second quarter as well. For your second question, the APR actually the average APR dropped a little bit in the first quarter. The average APR for the whole loan book is 29.3%. Now it's 29% and we see that APR continue to go down a little bit.

Alex Ye (Equity Research Analyst)

Thanks, Alex. Can I just have a follow-up quickly?

Alex Xu (CFO)

Sure. Yeah.

Alex Ye (Equity Research Analyst)

I would like to ask of your over 60 funding partners or how many of them are doing this capital-light model with us currently?

Alex Xu (CFO)

Currently only a few single digits right now, but we are talking to a lot of partners in the past few months.

Alex Ye (Equity Research Analyst)

Okay, great. Thank you.

Operator (participant)

The next question comes from Daphne Poon of Citibank. Please go ahead.

Daphne Poon (Analyst)

Hi, thanks for taking my question. So just one quick follow-up for me on the cost management side. So you mentioned about the South Asia costs. You will continue to invest in that. So I see your point about like seeing that as a long-term investment. But then in terms of the maybe more near-term margin outlook. So do you expect the operating margin will continue to decline because of the higher marketing costs and also any guidance or outlook for the customer acquisition cost level maybe for the next two quarters. Thank you.

Alex Xu (CFO)

Thank you. Daphne, you raised a very good question. Yes, the margin will continue from that perspective. The margin will drop down a little bit in the coming few quarters given that the acquisition cost will continue to go up as we see the competition is going up a little bit, but we have more channels in own discussion to mitigate that that cost. So I think that it's a very dynamic mechanism. It's a little bit difficult for us to foresee what exactly the number will be for the third quarter and fourth quarter. And to be honest in the third quarter. What we can see now the acquisition cost is actually draw down a little bit. So let's wait and see. But we will monitor that parameter on a daily basis and our CEO, Haisheng may add a few points on that.

Okay, I think that's pretty much it for your question. Hope that answers your question, Daphne?

Daphne Poon (Analyst)

Yes. So would you have any target on the operating margin or as a measure is quite dynamic?

Alex Xu (CFO)

From the operating margin we see they will be quite stable between around 40%. That's a non-GAAP basis and net margin will be around 30%-35%.

Daphne Poon (Analyst)

Okay, that's great. Thank you.

Operator (participant)

Once again if you have a question, please press star then one on a touch-tone phone. Again, if you have a question, please press star then one. This concludes our question-and-answer session. I would like to turn the conference back over to Matthew Li for any closing remarks.

Matthew Li (Director of Investor Relations)

Thank you, operator, and thank you, everyone, for joining us today on the call. So if you have any further questions. Going forward, please do not hesitate to contact us. Have a good day.

Operator (participant)

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