U.S. Markets open in 7 hrs 37 mins

Edited Transcript of XRF.N earnings conference call or presentation 21-Nov-18 1:00am GMT

Q3 2018 China Rapid Finance Ltd Earnings Call

SHANGHAI Jan 8, 2019 (Thomson StreetEvents) -- Edited Transcript of China Rapid Finance Ltd earnings conference call or presentation Wednesday, November 21, 2018 at 1:00:00am GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Junqing Shen

* Marlene Pan

China Rapid Finance Limited - Director of IR

* Russell Krauss

China Rapid Finance Limited - Co-CEO & Vice Chairman

* Zhengyu Wang

China Rapid Finance Limited - Founder, Co-CEO & Chairman

================================================================================

Conference Call Participants

================================================================================

* Daphne Poon

Citigroup Inc, Research Division - Associate

* John Cai

Morgan Stanley, Research Division - Research Associate

* John Hecht

Jefferies LLC, Research Division - Equity Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Hello, everyone. Thanks for standing by, and welcome to China Rapid Finance's Third Quarter 2018 Earnings Conference Call. (Operator Instructions). Please note that this call is being recorded.

Now I would like to turn the call over to the host for today's conference, Marlene Pan, Director of Investor Relations at XRF. Ms. Pan, you may begin.

--------------------------------------------------------------------------------

Marlene Pan, China Rapid Finance Limited - Director of IR [2]

--------------------------------------------------------------------------------

Thank you all for joining our third quarter 2018 earnings conference call. Please note that we have distributed our earnings press release and the slide presentation on our website, which is available to download and use to follow along with today's call.

Joining me today to discuss our results are Dr. Zane Wang, the Chairman and the co-CEO; our Vice Chairman and the co-CEO, Russell Krauss; and our CFO, Mr. Kerry Shen. Management will review the operating and the financial highlights of the quarter and then they will conduct a Q&A session.

Before we get started, I would like to remind you that our remarks today will include forward-looking statements. Those statements are prospective in nature and are subject to risks and uncertainties that may cause actual results to differ materially and adversely from the company's current expectations. Further information regarding these and other risks is included in our reports filed with, or furnished to, the SEC.

All forward-looking statements that we make on this call speak only as of the date hereof and are subject to change at any time. We undertake no duty to update these forward-looking statements.

And now, I'd like to turn the call over to Dr. Zane Wang, co-CEO of the company. Zane, please go ahead.

--------------------------------------------------------------------------------

Zhengyu Wang, China Rapid Finance Limited - Founder, Co-CEO & Chairman [3]

--------------------------------------------------------------------------------

Hello, everyone. I will start with an overview of our regulatory and market conditions, which are challenging; then Russ will cover our operating highlights, specifically our ongoing initiatives to reduce costs, operate more efficiently and continue to innovate in new product development. Finally, Kerry will cover the financials and then we'll open up for Q&A.

As a direction of our regulators, our industry is making significant progress in the reforms necessary to create a healthy and a safe lending environment for both investors and borrowers. The compliance framework being put into place is consolidating the P2P lending business with the serviceable platforms being reduced to a smaller group of lenders that consumers can trust. We are committed to being one of these leaders.

In September, we submitted all documentation required for the self-inspection process, the first of the 3 steps that lead to formal registration. We enthusiastically anticipated next verification steps to be performed by the authorities, which are expected to be complete before year-end.

In the current market environment, sustaining lending funding is critical to all players in our industry. During the third quarter, the funding environment was challenging, with a significant decline in total industry transactions. Notably, we and other industry participants saw a fair amount of disruption early in the quarter. In simple terms, some retail lenders went into wait-and-see mode due to a series of platform failures that people saw in the news. Fortunately, sentiment is now improving. We have seen ourselves that the institutions returned to lending on platforms such as ours. In particular, in Q3, we saw the return of the lending by new institution relationships. We are highly confident that both lenders and borrowers will rapidly return to P2P financing once the regulatory uncertainties clear out.

Regulatory actions will make it far safer for lenders. For borrowers, our industry still fulfills a massive unmet demand for consumer credit. Government policies are encouraging not only consumption loans for consumers but small business loans and credit in underserved rural areas. There's no reason that consumer credit in China should not track the same growth seen in developed (technical difficulty), where it plays a vital role in daily lives.

Let me now turn the call to Russ to cover operating highlights. Russ?

--------------------------------------------------------------------------------

Russell Krauss, China Rapid Finance Limited - Co-CEO & Vice Chairman [4]

--------------------------------------------------------------------------------

Thanks, Zane, and thanks, everyone, for joining the call today. Our operating results in the third quarter reflect the challenges faced by all participants as loan volume was down across the industry. In the third quarter, we accelerated 4 initiatives that improve our operating model. We're going to enhance risk management, reduce our operating expenditures, expand our product mix and build our senior leadership talent. As a result of these initiatives, we saw our operating performance remain relatively flat despite overall loan volume being down over 50% sequentially.

The first initiative, enhance risk management. In light of the concern that swept across some of the market early in the quarter, we increased our efforts in risk management to sustain the confidence of our lenders. We focused on improving the credit quality of our portfolio by continuing to focus on serving our repeat borrowers which have the best average credit quality. This shows up in our repeat borrower rate, which is high and stable at 75%. In addition, our average loan size continues to grow, up 24% since the first quarter. This dynamic is a core element of our low-and-grow strategy.

Furthermore, we tightened our risk management policies and improved our credit scoring system by utilizing additional big data sources and modifying certain collection activities. As a result, the annualized loss rate of consumption loans improved slightly versus Q2, a notable outcome given the level of disruption the industry saw this quarter.

The second initiative is the continued reduction of operating expenses. The ongoing cost actions we began in Q2 showed material improvement in Q3. Since the start of the year, cost-reduction initiatives enabled us to reduce the quarterly OpEx run rate by $4 million in each of the last 2 quarters, or $8 million since the end of Q1. Notably, in Q3, we reduced G&A by 10% sequentially to increase automation and other structural actions. Sales and marketing expenses were down 22% due to better selling efficiency, a further benefit of satisfying the demand of repeat borrowers. Finally, servicing expenses were cut 23% due to improved efficiency in customer and loan collection services. We will continue to evaluate ways to optimize our cost structure in the quarters ahead.

The third initiative is our new product design effort. We are now aggressively offering more high-value products and services to our customer base. We can see our progress by the improvement in our net revenue take rate. The take rate tripled to 9.1% this quarter from 2.6% a year ago and up from 5.6% in the prior period, reflecting the higher value we are offering our customers. Some examples are partnering with e-commerce platforms and sharing a percentage of margin or receiving referral fees. And through our platform, borrowers can finance their e-commerce purchases. Expansion and diversification of our business and product offerings enable us to monetize our customer relationships far beyond just loan originations. This is evident in our rapidly growing other revenue line, which was over $5 million this quarter versus a few hundred thousand in Q2.

In anticipation of an increase in industry loan volumes, we have made significant progress in reducing our breakeven level, enabling us to generate profits sooner than we could previously. Our breakeven quarterly loan volume was $324 million at the end of Q3 versus $596 million at the end of Q2, and we continue to bring this down. Current trends suggest that Q4 breakeven loan volume could go below $300 million.

Beyond optimizing our operating models, we are also investing in the future. In order to prepare the company for more sustainable growth in the long run, we remain committed to the investment needed to innovate in new products and services that can better serve the full spectrum of our customers' needs. By looking holistically at the customer relationships, we believe we can establish a growing stream of steady recurring revenue and profit that will help reduce the natural volatility we may see from time to time in the pure lending business.

Finally, our fourth initiative is our commitment to adding more talent to our leadership team. We recently welcomed a new Vice President of Finance, a new General Counsel and an Investor Relations Director. Each has extensive experience with best practices in their respective professional fields. Across the board, we are continuing to expand our leadership capability from both inside the company and out to meet the needs of our business and prepare for the growth we anticipate in the quarters ahead.

To summarize, Q3 was one of the most challenging periods of China's online lending industry. Like our peers, we saw reduced loan volumes due to market conditions. While we responded with certain actions pertaining to these short-term events, we remain focused on our longer-term strategy. We focused on our customers, significantly lowered our breakeven level and aggressively introduced new ways to better monetize our large customer base.

Our take rate is up substantially while operating expenses are down. We are confident that our initiatives are taking hold and position us for better performance in the months and quarters ahead.

Now let me turn the call over to Kerry for the financial details. Kerry?

--------------------------------------------------------------------------------

Junqing Shen, [5]

--------------------------------------------------------------------------------

Thank you, Russ. And thank you, everyone, for joining our call today. I will now review our financial performance.

Our press release and supplemental slides contain all the figures and comparisons you need. I'm not going to repeat all the numbers. Instead, we are going to focus on the analysis of the factors that influenced the results. Keep in mind that we're referring to Q3 figures unless I say otherwise, and all the comparisons are quarter-on-quarter basis unless stated otherwise.

In the third quarter, lower loan volumes drove the decline in all our top line metrics, as you would expect given market conditions. Net revenue was $18 million, down 35% year-over-year and 23% sequentially.

As Russ mentioned, we are better monetizing our loan origination activity as demonstrated in the higher take rates. This is a function of the new value-added products and services we are offering to our customers. Those fields appear in other revenues, which went from around $350,000 in Q2 to $5.4 million in Q3, accounting for 31% of net revenue. Our research and development team is aggressively experimenting with new product offerings that should drive the proportion of other revenue even higher in the quarters ahead. The cost-cutting efforts we initiated in the first half are bearing fruit, as you can see in our lower operating expense run rate this quarter. The operating expense run rate decreased by over $4 million, down by 13% from the Q2 level. Net loss was $11 million, relatively flat to the $10.6 million in Q2. The change was minimal when viewed in light of the 52% decrease in total loan volumes. Our restructuring activities was effective in mitigating the impact of China's market conditions.

A quick comment about our balance sheet. We continue to monitor the liquidity requirements, both current and future, to ensure that we maintain a sufficient cash balance and accessible credit. At quarter-end, we have cash equivalent of $39.2 million and other current assets of $13.8 million.

Finally, let me comment briefly on our outlook. Our industry is undergoing major changes due to regulatory uncertainty. As sentiment improves, institutional lenders are returning and we are working hard to accommodate their needs. Our pipeline of interested institutional lenders is growing, so we feel confident that our funding sources are on the upswing. As funding improves, loan volume and thus, revenue generation can grow. Growth will be further supported by new revenue streams from non-lending value-added services. With the lower breakeven volume enabled by our extensive cost reduction programs, we are confident that we can improve our financial position going forward.

With that, we will move to the Q&A session. So operator, can you begin?

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) The first question comes from John Hecht with Jefferies.

--------------------------------------------------------------------------------

John Hecht, Jefferies LLC, Research Division - Equity Analyst [2]

--------------------------------------------------------------------------------

Zane, you talked about the compliance and how you guys were early in applying. Can you give us a sense when you think that all the required approvals will be taken care of and when you think the overall regulatory environment will stabilize and the companies that are poor performers would be inoperable?

--------------------------------------------------------------------------------

Zhengyu Wang, China Rapid Finance Limited - Founder, Co-CEO & Chairman [3]

--------------------------------------------------------------------------------

John, thank you for the question. We talked about the overall compliance framework. Actually, we all know the industry has experienced major changes, and the overall framework laid out by the regulators were quite clear. There's going to be a 3-steps process for 2018. We completed the first step by September 30 by completing to submit the -- all the required documents. Now, we are in the second and third stage, which is doing the self-checking and the on-site verification. We anticipate this process should be completed by the year-end based on the regulatory's -- the announced time frame. Then this will be the major work done for this year and based on regulatory's overall -- the framework for next year 2019 that start so-called registration process for a few successor players and complete this process. So this is the overall framework. Right now, the major focus for regulators are really the compliance. Right now, we are working very closely with regulators. We're confident we shall move into that direction.

--------------------------------------------------------------------------------

John Hecht, Jefferies LLC, Research Division - Equity Analyst [4]

--------------------------------------------------------------------------------

Okay. And given all that timing, I think one of you mentioned some potential loan volume figures for the fourth quarter. At what point would you expect the loan volumes to neutralize and begin to grow? And how many market participants would you think will be around when that occurs?

--------------------------------------------------------------------------------

Zhengyu Wang, China Rapid Finance Limited - Founder, Co-CEO & Chairman [5]

--------------------------------------------------------------------------------

As of today, the overall requirement from regulators still try to come through so-called non-compliance growth of the volume. But the language that regulators use is for the control for non-compliance volumes. So we assume after this self-checking process and so-called the -- those compliant business model or business practice should be allowed to grow. That's our understanding.

--------------------------------------------------------------------------------

John Hecht, Jefferies LLC, Research Division - Equity Analyst [6]

--------------------------------------------------------------------------------

So is that just a couple quarters or is it a longer -- is there uncertainty? Or do you have any visibility to that?

--------------------------------------------------------------------------------

Zhengyu Wang, China Rapid Finance Limited - Founder, Co-CEO & Chairman [7]

--------------------------------------------------------------------------------

We anticipate that this process should be complete -- the current process should be complete by year-end. So hopefully, moving to 2019, the things are getting better in terms of the overall market sentiment.

--------------------------------------------------------------------------------

John Hecht, Jefferies LLC, Research Division - Equity Analyst [8]

--------------------------------------------------------------------------------

Okay. And then final question is maybe could you go -- you've talked about some of the partner with the other e-commerce sites and how that drove a big increase in other revenues? Maybe can you give us some more details about that? And is this a good base rate that should grow from here? Or is the -- how do we think about this line item?

--------------------------------------------------------------------------------

Zhengyu Wang, China Rapid Finance Limited - Founder, Co-CEO & Chairman [9]

--------------------------------------------------------------------------------

Yes, John, thank you for -- actually, this is a very important issue. We actually grow our business knowledge just based on the lending activities. We also try to realize the customer's lifetime value. So I would -- for this part, I will ask Kerry to give more details.

--------------------------------------------------------------------------------

Junqing Shen, [10]

--------------------------------------------------------------------------------

John, this is Kerry. I guess you have realized that our net revenue take rate is in an increasing trend quarter-by-quarter. In Q1, this was 2.6%; in Q2, 5.6%; and this quarter, it arrived at 9.1%. Out of the blended 9.1% take rate, 11.7% is for the lifestyle and 7.9% for the consumption. And if I put a breakdown, the 7.9% from consumption, 3.9% is coming from transaction and service fees, and 4% coming from the non-P2P business. In the P&L, such revenue is recorded and the other revenue amounting to USD 5.3 million. This is mainly achieved by innovation in product designs. We time that with some e-commerce platforms and we receive referral fees from them or either -- or we share a percentage of the gross profit margins. We finance our borrowers in their online purchases. However, all the loans we provided to borrowers has an APR under 36%, so it's fully compliant with the regulatory requirement. And we think we will continue to innovate our business model and further diversify our products to, as Zane said, address our customer needs and maximize the customer value.

--------------------------------------------------------------------------------

Operator [11]

--------------------------------------------------------------------------------

The next question comes from John Cai with Morgan Stanley.

--------------------------------------------------------------------------------

John Cai, Morgan Stanley, Research Division - Research Associate [12]

--------------------------------------------------------------------------------

I have 3. The first one is to follow up on the other revenue. I just want to clarify that the 4% consumption loan take rate you guided on the P2P business is still from providing funding to the customer and also whether this funding has been included in our loan facilitation number? So that's the first question. The second question is on the funding side, both institution and the retail. And I think this on balance sheet loan of around $11 million as of 3Q, and I'm not sure if that's from the institutional funding or if not, then what type of amount are we looking for in terms of the institution funding source? So -- and the second question is -- sorry, on the retail funding part, I think based on the public data from the National -- Internet Finance Association, it seems the loan balance from the P2P is still declining in September and October. I'm not sure whether in November, this trend has been reversed. And so both combined, what's our outlook for the funding going forward in the remainder of the year? And how would that impact our loan facilitation outlook? And the third question is on the OpEx. I think in September -- in June, the OpEx -- once the OpEx has been reduced to around $10 million, it seems marginally flat in the third quarter. I'm not sure if that's the stable level we should expect at around $10 million a month.

--------------------------------------------------------------------------------

Junqing Shen, [13]

--------------------------------------------------------------------------------

This is Kerry. Thank you for your questions, and let me handle them one by one. The first question, yes, the model is -- we first finance the borrowers in their online purchases, so in form of a loan. And then that loan is captured in the total loan volume of USD 194 million. And then in return, we receive a referral fee or share percentage margin from the business partner, which we said is recorded as other revenue in the P&L. The second question, I appreciate that you noticed that we have $11 million investment. This is an investment in our trust program, so it's recorded on our balance sheet. And included in the $11 million, we participated USD 3 million as well as an investment. This investment is total program is shorter than 12 months. So it's a current asset. And your third question regarding the loan balance, actually, the portfolio loan balance is not our key metrics. We track loan volume gross billings and take rates. And also because of the turnover of lifestyle loans and the consumption loans are pretty different. The lifestyle loan is generally about 20 months and consumption loan is 30 days. So we don't talk about total loan balance as a blended portfolio. Regarding your last question on OpEx, yes, we did a pretty good job in streamlining our operations. If you recall, in the first quarter, our total OpEx was $37 million; and in Q2, it was $33 million; and in Q3, it's further down to $29 million. So $4 million down on a quarterly basis. If you annualize it, that's $60 million. If you annualize it against the first quarter, it's probably $32 million. So the current operation side is pretty much efficient. And for your question getting into the fourth quarter, we think we can maintain our OpEx at a similar level and operate in an efficient manner. So does that answer all your questions?

--------------------------------------------------------------------------------

John Cai, Morgan Stanley, Research Division - Research Associate [14]

--------------------------------------------------------------------------------

Yes. Just 1 quick follow-up. So based on your observations in the fourth quarter so far, how do you feel about the loan volume?

--------------------------------------------------------------------------------

Junqing Shen, [15]

--------------------------------------------------------------------------------

We do see in the third quarter, there are some market condition changes in the investor community. So consistent with the investor trend, our loan volume is also down smaller in the third quarter compared with the second quarter. And some other numbers, including number of investors, for example, decreased from 18,000 in end of Q2 to 15,000 in end of Q3. So this is mainly caused by investors' concern due to regulatory uncertainty. However, getting into September, we have seen positive changes. One change is that institutional investors have increasing interest. Some institutional investors that exited in Q1 is returning in Q3 to reinvest on the marketplace, and we have more in the pipeline for institutional investors. And getting to October and November, first half of November, we see the net funding has turned positive. All these told us that investor confidence is building. And I hope this information is helpful in helping you evaluating the trend of the loan volume in Q4 and for the quarters ahead.

--------------------------------------------------------------------------------

Zhengyu Wang, China Rapid Finance Limited - Founder, Co-CEO & Chairman [16]

--------------------------------------------------------------------------------

John, this is Zane. Let me add another point about what Kerry just said about the overall market environment. Regulators are actively pushing for several nationwide credit reporting services, and they did produce injunction with the overall regulatory framework for the online lending industry. So helping the industry go healthy and provide a safer environment for lenders and borrowers. So we actively participate almost all of those nationwide credit reporting services sponsored by the government, by the regulators. So we think this also provides a very good positive view of our industry's outlook.

--------------------------------------------------------------------------------

Operator [17]

--------------------------------------------------------------------------------

(Operator Instructions) The next question comes from Daphne Poon with Citi.

--------------------------------------------------------------------------------

Daphne Poon, Citigroup Inc, Research Division - Associate [18]

--------------------------------------------------------------------------------

So first, I just want to follow up on the loan volume. So on the loan volume contraction in 3Q, is that above 50% Q-on-Q? So it's actually bigger than the industry average level and also some of the other list of peers levels. So I would be wondering whether that's purely due to the industry-wide funding tightness on the retail side or there is also some component that you have been proactively tightening on your loan approval, given, like, potential asset quality concern. And secondly, just on the institutional funding side, so can you give us an update on, like, what is the current percentage contribution from the institutional funding partners? And also, who are those, like, funding partners? Like, what type of institutional investors they are? Like, are they trust companies or mainly banks or customer finance companies?

--------------------------------------------------------------------------------

Junqing Shen, [19]

--------------------------------------------------------------------------------

Daphne, this is Kerry. Thank you for your questions. Regarding the loan volume in the third quarter, I think there are 2 main reasons for the decrease in loan volume in the third quarter. The first is that our strategy is focusing on repeat borrowers to generate and maximize the customer value. So you realize that the new borrowing numbers are still pretty small. And then even within the repeat borrowers, we pick the top quality borrowers to underwrite them loans in the second quarter. And another reason -- sorry, in the third quarter. Another reason is that as you have seen that we are very active in product designs, we developed a number of new apps and also updated the consumption and lifestyle loan apps a couple of times. And then the change in business model and the product design will require a lot of testing. So after a lot of testing work, we are very happy with the customers' response rate. They like the product, they appreciate the product and then our business partners are happy with the terms. So this testing work is also one of the reasons why we control our loan volume. So I would say we are very well positioned in controlling the pace of the business. And then getting into the fourth quarter, I think we have innovated our products. We have successfully increased the net revenue take rate. And also, we have successfully cut it, operating expenses, streamlined operations to make ourselves more efficient. So we think we are pretty good, well positioned on the right path. And then your second question is regarding the institutional investors. Yes, diversification of our lender base is always our strategy. And we are gradually increasing the portion that we offer to institutional investors. Currently, I would say the institutional investor portion is below 10% of the total portfolio, but we welcome more institutional investors who have a higher capability of bearing the ultimate risk and collecting portfolios. So we appreciate partnering with them and we offer them more opportunities to invest on our marketplace, particularly in high-quality consumer assets, which is not too much available in the marketplace.

--------------------------------------------------------------------------------

Daphne Poon, Citigroup Inc, Research Division - Associate [20]

--------------------------------------------------------------------------------

So regarding the loan volume, given that you are still a bit cautious, like, in terms of your borrower selection, does it mean that going into Q4, even with the funding side, like, recovering, that probably will not go back to the, like, 2Q or 1Q level bastion?

--------------------------------------------------------------------------------

Junqing Shen, [21]

--------------------------------------------------------------------------------

Yes, we will manage the pace depending on the need. We may continue to develop more products, including the consumption loan plus providing more installments in the consumption loans. So we may do more product offerings and then the growth will be subject to the business strategy and operational needs.

--------------------------------------------------------------------------------

Operator [22]

--------------------------------------------------------------------------------

(Operator Instructions) Seeing no more questions, I'll turn the call back over to Dr. Zane Wang.

--------------------------------------------------------------------------------

Zhengyu Wang, China Rapid Finance Limited - Founder, Co-CEO & Chairman [23]

--------------------------------------------------------------------------------

Thank you, operator. Before we conclude, I want to summarize the key takeaways from the call. Due to the uncertainty still surrounding our industry, we will continue to operate prudently, consistent with improved operating efficiencies and the increased contributions from our new products and services. As loan volumes recover across the industry, we anticipate progressive improvement in our financial performance, and we're confident that China Rapid Finance will emerge from this uncertain regulatory period with a streamlined and a powerful business model that offers excellent growth and value.

This concludes today's call. Thank you all for your interest and support.

--------------------------------------------------------------------------------

Operator [24]

--------------------------------------------------------------------------------

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