Sos Ltd (SOS) 2017 Q3 法說會逐字稿

Welcome to China Rapid Finance's Third Quarter 2017 Earnings Conference Call. (Operator Instructions) Please note this event is being recorded. (Operator Instructions) I would now like to turn the call over to your host for today's conference, Mao Mao, Investor Relations Director of China Rapid Finance.

Thank you, operator. Welcome to China Rapid Finance Third Quarter 2017 Earnings Conference Call. Today's call is being webcast and is accompanied by a slide presentation, which is also available on our website.

With us today are Dr. Zane Wang, our Chairman and CEO; and Mr. Kerry Shen, our CFO. Following management's prepared remarks, we will conduct the Q&A session.

Before we begin, I will refer you to the safe harbor statements in our earnings press release, which also applies to the conference call today as the company will make forward-looking statements. These forward-looking statements involve inherent risks and uncertainties that may cause actual results to differ materially from our current expectations. Further information regarding these and other risks is included in China Rapid Finance report published or furnished to the SEC. All forward-looking statements that we make on this call can speak only as of the date hereof and are subject to change at any time. China Rapid Finance has no duty to update these forward-looking statements.

With that, I will now turn the call over to Dr. Zane Wang. Zane, please proceed.

Thank you. Hello, everyone. Thank you for joining our Third Quarter 2017 Earnings Conference Call today. I'm going to start with an overview of the quarter, followed by an update of our business operations. Then I'll turn the call over to Kerry, our CFO, to discuss our financial results and outlook in more detail.

Our strong performance this quarter validates the effectiveness of our low and grow model, driven by our proprietary technology-enabled consumer lending marketplace. As such, we are uniquely positioned to fulfill the lifetime consumer credit need for China's 500 million EMMA consumers. During the third quarter, the effect of low and grow business model start to scale as evidenced by this result.

First, cumulative loan volume continue to grow. Second, average loan size continue to grow. Third, number of repeat borrowing continue to grow. Fourth, our average take rate continue to increase while borrowers monthly borrowing cost continue to decrease. Fifth, cumulative gross billings continue to grow.

All the above factors contributed to a significant lifetime customer value. Our unique low and grow business model is also associated with the following 3 important components. The first is our pure marketplace model with a full risk transfer. The low and grow model does not bear credit risk. Unlike other players, whose balance sheets are exposed to credit risk, our marketplace is one of the few in China with the full risk transfer to a diversified base of sophisticated marketplace investors.

This provides a more stable source of lending capital. We continue to focus on maximizing marketplace investors returns, while achieving a good balance between risk quality -- returns.

For the 3 quarters, ended September (inaudible), the loss rate of consumption loans defined as any loan principal that remains delinquent for more than 90 days. As a percentage of a total loans originate, net of the consumption loans issued that could not result in such delinquency is 2%, which is consistent with the prior year's period. During the third quarter, we continued to expand our lender base to high net worth individuals, family offices, online affluent and institution investors. As of September 30, 2017, the number of investors our marketplace approximates 13,000.

Secondly, we believe providing affordable credit to EMMA, who do not have credit access, is critical to winning customer loyalty, which is the foundation of low and grow. Our fee rates are similar to bank charges of prime credit cardholders who withdraw cash, for instance, for RMB 500 loan in 2 weeks, banks charge a 2% transaction fee plus 18% APR. A lot of players in China are charging much higher rates because they are targeting lower quality even subprime borrowers. That may be very profitable at the very beginning during the record growth stage. But our business model is a suitable and more profitable in long run.

We are now focused on onetime revenue that do not recur. We are focused on generating recurring revenue that growing large over time by providing them affordable credit. And so we believe, a high-quality borrower base comprised of prime and near-prime young generation who will repeat and grow with us over a very long time is the key to our success.

And finally, we believe our proprietary analytics and data technology truly make the low and grow possible. Part of that difference is the depth, breadth and the diversity of our data sources.

During the third quarter, we continue to deepening our relationships with existing data partners and then continue to utilize the data from a variety of data source to better refine our proprietary algorithms. We also continue to explore partnerships with the new data channel partners in relation to data collection and the customer acquisition.

We remain committed to our model data channel strategy. Not only are we able to keep refining our credit models by leveraging a vast amount of customer data, we also achieve data channel diversification and lower our concentration risk through our unique low and grow business model and the development of our proprietary technologies.

Our marketplace is effective able to better assess the credit worthiness of potential borrowers. Therefore, we're able to identify and effectively select prime or near-prime EMMAs, offer them smaller, short term, affordable (inaudible) to start with, and then retain quality EMMAs by offering them (inaudible) longer-term loans, as they demonstrate good credit behavior. These capabilities have allow us to generate significant lifetime customer value concurrently with recurring revenues.

With that, I would now turn the call to Kerry, our CFO, for our third quarter of 2017 financial results and outlook.

(inaudible) Thank you, Zane. I will first go through our financial highlights in the third quarter of 2017, then, I'd like to highlight some of the key performance metrics that validate our business model. Lastly, I will share our outlook for the full year of 2017.

We were pleased with the third quarter financial performance. Total gross billings on transaction and service fees grew by 125% year-over-year to 41 -- USD 43.1 million, driven by the rapid growth in our consumption of business, which increased by over 12x year-over-year to $29.8 million. Gross billings for lifestyle loans declined by 21% year-over-year and increased 18% sequentially over the previous quarter to $13.4 million. Consumption loans accounted for 69% of total gross billings for the third quarter as compared to 11% in the prior year period and 54% in the previous quarter. This is in line with our ongoing strategy to focus on consumption loans as our key growth driver.

Net revenue for the third quarter increased by 62% year-over-year [to $27.2 million] after netting off customer acquisition incentives, or the CAI, of $13.9 million, up from $16.8 million in a prior year period, which netted off CAI of $1.5 million.

Total operating expenses were $31.6 million for the third quarter, an increase of 50% over the prior year period and 10% over the previous quarter. Service expenses was $3.4 million in a quarter, a 9.4% increase over the prior year period primarily due to change in our number of servicing personnel.

Sales and marketing expenses were $11.9 million, increasing by 77.8% over the prior year period and 24.6% over the previous quarter. The increase was primarily due to the marketing fees paid to channel partners in connection with our acquisition of 921,000 new consumption loan borrowers. Our all-in customer acquisition cost, including customer acquisition incentives and expenses recognized as sales and marketing expenses is $16 per borrower for 2017.

General and administrative expenses were $16.3 million, up by 44.9% over the prior year period or 4% quarter-over-quarter. The increase in G&A expenses was mainly due to, one, the increase in operating costs in relation to the facilitation of consumption loans, including information security, risk management, gateway payment fees, data analytics, customer services, call centers and other operational personnel; two, the increase in research and product development expenses; and three, share-based compensation expense for incentive shares of $0.4 million versus $0.1 million in the prior year period.

Relative to our 12x year-over-year growth and 126% quarter-on-quarter growth of total gross billings in our core consumption of business, we achieved significant operating leverage in the third quarter. We reported a net loss of $4.4 million for the third quarter, a year-over-year increase of 11%, and a 68% reduction from $13.5 million in the previous quarter. The improvement is attributable to the increasing number of borrowers who have crossed the breakeven threshold.

Net loss per ordinary share attributable to ordinary shareholders was $0.07 per share as compared to a net loss of $0.38 in the prior year period. As of September 30, 2017, the company has cash and cash equivalents of $81.4 million and restricted cash of $14.1 million. Net cash generated from operating activities was $7.1 million for the third quarter as compared with $322,000 in the prior year period minus $16.2 million in the previous quarter.

Now let me take a few minutes to talk in greater detail about our core consumption of business. As of the third quarter of this year, we're pleased to see the business continues to deliver against the key performance indicators as cohort borrowing activity continues to grow.

One, as shown on Slide 21, cumulative consumption loan volume per borrower for all borrower cohorts is growing without any signs of slowing down. Our Q1 2015 borrowers are still growing after 10 quarters. This is low and grow in action, indicating a long-term loyal customer relationship. Through repeat borrowing behavior and proactive line of credit management, we generate lifetime customer value.

Two, moving to Slide 22. This is exactly what we mean by low and grow. We have been able to consistently increase the average size over time using our automated decisioning technology, which is key to help our borrowers to grow. We started by upgrading our borrowers' line of credit by modest increments in a second or third month.

After [18 to 12] months, we have accumulated sufficient credit behavioral data to begin to further accelerate the line growth, which is (inaudible) happening here. Management of this higher credit range requires credit-score-driven line of credit management strategy, implementation mechanism and a deep understanding of credit data, not just so-called Big Data collectives in application page. We now have enough data so that the time needed to triple the average loan size per borrower has shortened from 21 months to 15 months, and we expect to continue this trajectory.

Three, on Slide 23. We are showing a cumulative number of repeat loans per borrower. On average, all borrowers borrow 10 times during a first 12-month period. As the average size of the loan gets larger and the loan duration gets longer, it is natural that the number of repeat borrowings we need within the same period decreases, however, cumulative loan volume per borrower still keeps increasing as you saw on Slide 21. That's why affordability is a very profitable win-win strategy in the long run.

Fourth, as shown on Slide 24. As the loan size gets larger, the term of loan is generally longer and our take rate is higher. That's maximizing revenue and producing a recurring stream. From a borrower's perspective, the monthly borrowing cost is lower as the term of the loan gets longer and the loan size gets larger. Compared with banks, [card cash residual] cost. The increase (inaudible) after 12 months is in line with our line of credit management strategy as shown on Slide 22.

Five, as a result, as illustrated on Slide 25, gross billings per borrower grew 10x on average in 8 quarters. The more credit cohorts -- the more recent cohorts are growing at a faster pace. That's the power of low and grow models.

Sixth, as you can see on Slide 26, the time needed to recoup all-in CAC shortened from 8 quarters to 4 quarters from 2015 to 2016. And in 2017, it came further down to 2.3 quarters. 9 out of the previous 11 quarterly borrower cohorts since 2015 have crossed the breakeven volume point. The remaining 2 cohorts, namely Q2 and Q3 2017 cohort, are tracking toward breakeven at a faster pace. Our profitability trajectory is both variable and sustainable. As our improving KPIs demonstrates, our low and grow model afford to invest in CAC to lock in high-quality repeat borrowers.

As you can see, ROI on all-in CAC is already more than 2x for earlier cohorts. More importantly, with our customer retention rates of 75% and customer repeat borrowing rates of 9 to 10x on average during their first year. We're pleased to see (inaudible) from all cohorts continue to be very active and repeatedly return to our marketplace for their credit needs. Thus, the respective ROIs on CAC continue to increase over time. We expect our quality borrowers to generate recurring revenue growth at minimal additional cost. And we'll continue to apply new borrowers. We expect both revenues and profits to accelerate.

With that, let me provide an updated financial outlook for the full year of 2017. For the full year ending December 31, 2017, the company expects to exceed the high end of its previously stated guidance of adding 2.5 million to 3 million new borrowers. It also expects to exceed the high end of its previously stated guidance on total gross billings of $110 million to $120 million.

With confirmed validation of our low and grow strategy, along with improving operating efficiencies and visibility, the company expects to achieve breakeven in the entire business and achieve profitability in the fourth quarter this year. These forecasts reflect the company's current and preliminary view, which may be subject to change.

Now we are ready to open the call to Q&A. Operator, please proceed.

(Operator Instructions) The first question comes from Richard Xu of Morgan Stanley.

I have 2 questions. Firstly, I just want to see the -- basically the fee rate. It's actually the take rate on the new loans. I understand the many new borrowers have been upgraded to the higher loans with higher balance and also higher duration was the -- basically was the fee rate -- current fee rate on those loans and the average fee rate seems to be about 2 -- 3.3%. And also, you mentioned that the average monthly cost is actually lower. I don't know if there is a calculated APR for the longer -- for the larger loans with longer duration? What's the APR equivalents? And then secondly is basically on the regulatory front, there's been a lot of attention on this business, basically, in China from regulators. I don't know if there's any discussion that you had with local or national regulators on this front? And do you expect any changes on the regulations with regard to APR or other type of practices by the industry at the moment?

Richard, thank you for asking the question. It's nice (inaudible). Before I explain in detail (inaudible) both the changes in fee rates and then the trajectory growth in gross billings, as it's closely tied to the low and grow strategy and business model, maybe let me first have our CEO, Zane, introduce unique low and grow model, and then, I will follow up.

Yes. Probably you observed our gross billing outpaced the growth of the loan origination. The reason for this is not because we change our pricing scheme. The key driver to this is the power of a low and grow. When new borrowers enter our marketplace, they start with the low amount, short duration and affordable rate which is comparable to bank's credit card charging rate. As they grow out our platform, cumulative good credit behavior, we help them to access the higher loan amount, longer duration, lower monthly borrowing cost. Because the duration is longer, the total gross billing rate is higher. That's why our business model will be much more profitable and healthier in long run. And now let me turn to Kerry to explain the financial consequences.

(inaudible), Zane. And Richard, I appreciate that you noticed that the changes in take rate and changes in the gross billings. As shown on Slide 14, [our] functional business grew 5x year-over-year and gross billings grew 12x year-over-year. And on Q-on-Q basis, consumption loan volume grew 42% while gross billing grew 125%. So the gross billings growth rate outpaced that of the consumption loan volume. The reason -- in answering this question, let me first give you an example. When new borrowers come to a marketplace for the first time, we only charge them 1% to 2% on an average $100 loan. After paying CAI, actually, the financial statement is reporting a loss. As of today, this is still the case for new borrowers. That's why Zane said that we have not changed our pricing scheme. When the -- these borrowers grow with us, good borrowers will be identified based on their credit behavioral data and will be offered larger loan size to a couple hundred U.S. dollars. And their loan term will be extended to 2 to 3 months. Our fee rate increases to 2% to 3% and further to 3% to 4% while the monthly rate is even lower, from the borrower's perspective, compared with the initial loans. When borrowers continue to repeat at larger size, we generate recurring revenue at higher fees without paying CAI anymore. That's how you can see gross billing growth rate outpace that of the loan volume. We want to say this, it's just the beginning. We now have 3.7 million cumulative borrowers, 75% of which are repeat borrowers. As we continue to build our customer base, we expect more and more borrowers will have the opportunity to go through this journey with us. Such trends will be even more significant when a larger proportion of borrowers have been upgraded to a higher loan amount. I want to reiterate Zane's view that this is really the power of low and grow and the beauty of our business model. That's why Zane told you this business model will be more profitable and healthier in the long run. I hope that answers your question.

Yes, Richard, let me address your second half of the question, which is regulatory discussions about set the interest rate charged by P2P companies capped at 36%. Currently, the interest limit is like 24% or 36% -- those numbers are discussed -- refer to the interest rate charged by lenders. The regulators have not made it clear whether all the fees charged by platform should be included into the calculation. In practice, when banks categorize their APRs, they don't include any fees charged to the customer. For instance, when a credit cardholder do cash advance, banks charge 18% APR plus 2% fees. If you calculate the all-in cost for short-term borrowing behavior, it would be higher than 36% in terms of the effective APR. Our fee rates are comparable to what banks charging prime customers of similar products.

The next question comes from [Doris Tan] of Credit Suisse.

So I have like basically 2 questions. The first one is, may I ask about -- how the company plans to utilize the IPO proceeds in the future business? And do you have any like plans for -- in the future? And the second question is more like a follow-up on the previous question regarding the regulatory requirements of the 36%. So may I ask what's the company's current APR definition? So basically, I (inaudible)

[Doris,] nice having you here. It's Kerry. For your first question regarding use of proceeds, actually we raised [USD 105 million] during the IPO. Net proceeds is about USD 60 million. The IPO was done in April this year, and during the second quarter and third quarter, one of the user proceeds as we use it to do customer acquisition to lock in the high-quality repeat borrowers. We used about (inaudible) U.S. dollars in doing customer acquisition. This is in alignment with what we said for the use of proceeds, during the IPO. And then remaining money, we may use it to make strategic investments in certain companies, and we may also use the remaining proceeds for general corporate purposes. And regarding your second question, the 36% APR, I'll have our CEO, Zane, handle this question.

Thank you, [Doris.] We actually -- in our view, APR might not be the relevant metric for our short-term duration on the consumption loan product. For consumption loans, we typically charge 21% interest but 1% to 2% in transaction fee on the loan principal, which is very similar to the case I discussed earlier about banks, credit cards using -- if you're using credit cards to do cash advance. In China, the EMMA population we served, they'll have no access of our bank's credit service, and much of them -- and our overall rate is much lower than most of our online competitors. Our lifetime -- lifestyle loan typically charge about 12% to 15% interest plus about 11% of the loan principal as a transaction fee. Because that's for a much longer period, obviously. [Doris,] I don't know if I addressed your question?

Yes. May I just follow up on the (inaudible) process. You say that the strategic investment are -- you may -- the company may consider some strategic investment in certain companies. May I ask, too, does the company have any specific target now? Or it's just like a general consideration?

Yes, we are evaluating a number of options. We do have good opportunities that can help to add to the value chain of our business that can help to -- that can help with our low and grow strategy and business model. We are evaluating an option. So far we don't have a definite objective -- objects as a investment target.

The next question comes from Ryan Roberts of MCM Partners.

My question actually is a little bit involving industry and a little bit kind of involving what makes us -- the different -- from some competitors. It seems like in the industry, there are -- is an overall trend to providing -- platforms providing guarantees or any kind of risk reserve kind of safeguarding assets for investors. And I'm just wondering, since we use kind of a direct pass-through, does that have any impact on our ability to attract investors who are taking on the credit risk? And just kind of curious about the mix and the outlook for investors on the platform going forward?

Thank you, Ryan for the question, this is a very important one because we -- as a pure marketplace platform, we actually don't take a credit risk, and typically, we don't (inaudible) publicly or individual companies, in terms of their balance sheet or in terms of other business models. Let's discuss the different business models in general. But the balance sheet model also called the risk-sharing model, requires building of a risk reserve as the platform takes ultimate credit risks. It may turn out to be profitable at the very beginning, even very profitable because you earn additional interest margins on top of transaction fees. As the portfolio size that quickly grows, risk is always -- have a delay factor, so the risk of performance all seems promising so the burden on risk reserve is not apparent at the beginning. All this contribute to extremely high net profit margin. We noticed some companies in the market charge a very high rate compared with the banks' charging rate, as I discussed earlier. While their overall reported loss rate are lower than banks' credit card prime or super prime credit card portfolio, which typically annualize as to 2% to 3%. This could be successful, but I think the textbook of a consumer finances rules might be rewritten. Based on my experience in the consumer finance industry for more than 2 decades, eventually, the growth rate of our loan book slows down or macro-economy slows down and the credit cycle hits. [Lastly] starts to deteriorate very quickly. I've seen some high flyers balance sheet players disappeared because of this reason. After all, it doesn't matter. It doesn't matter if it's balance sheet or off-balance sheet. It's all tied to right affordable consumer credit to channels amount of the untouched EMMA population of -- with 500 million people in it. So in the end, it's the lifetime value -- customers' lifetime value matters, we think it's a long journey not a short race. So in our mind, it requires a vision and a strong belief, and additional, we need a little bit patient to see how we can do it using our low and grow model to fulfill the lifetime credit need of our EMMA population we're serving. That's why I'm a strong believer of off-balance sheet model. Ryan, I don't know if I addressed your question.

It does and just kind of one quick follow-up on that, in terms of the -- given the -- what you're saying is like the pass-through kind of a situation with the risk. Does that have any impacts, or in your view, is that -- maybe it's self-selecting in terms of the types of investors that will invest in the platforms. It sounds like there's a definite requirement, definite need to, I guess, understand kind of what you're talking about is the consumer credit cycle. And some investors perhaps might not be that sophisticated, and I'm just wondering -- I'm talking about the mix of investors over the longer term, how you see that shaping up. And that's all from me.

One of the unique features of our business model is we serve a diversified the sophisticated investor base, which are high net worth individuals, online affluent and also institutional investors. When we see they're sophisticate, they understand the risk of return on our principals. They also understand to track the historical performance, and we have around 13,000 -- of our 13,000 investors in total verses about 3.7 million borrowers in total, so look at the ratio with a fairly small amount of sophisticated investors who (inaudible) risk, and we use our technology to control the credit risk, to help them understand the credit risk, that they can take credit risk.

The next question comes from Mike Del Grosso of Jefferies.

I guess kind of following up a bit on the previous questions is, could you comment on the competitive environment and specifically kind of, are you seeing any impacts from new entrants on the loan economics or potentially borrower demand from your perspective? I mean, it seems like this quarter, very strong results, so if you could comment on that?

This is a good question, actually. Really, when we sit back, really look at our unique business model, and the -- even though there seems like a quite dynamic environment, some players attract public attention. But in our model, there are some key differentiating factor. We don't feel like we have a very crowded space here, instead, our model is kind of unique. The first is low and grow model. We start lending to our borrowers at a very low amount, typically in like $180 even. So in this space, not many lenders are active in this space. The second is (inaudible). We provide -- as I keep saying, we provide very similar service rate or charging rate, interest rate to banks' planned credit cardholders. So when we do that, this affordability really sets us apart from most of other lenders or most other platforms who charge much higher rate. The third, we focus on lifetime value. Our low and grow model enable us to have long-term relationships with our borrowers, who will repeat borrow at increasing amount. Instead of [just] doing onetime charge, charging onetime service fee, we actually service them in long run, will make our business much more profitable in long run. So that's why we don't feel, in our space, in our unique model -- we're very proud, actually, we have a very unique, very differentiated model here.

I guess the next question is probably more suited to Kerry. Understanding the kind of the full year guidance, I know you're taking it to the top end of the range on gross billings and transaction services, but can you provide some more color on kind of the underlying drivers behind that? I understand the take rate was higher this quarter but any commentary on some of the factors leading to that and then as well as kind of seasonality as we head into 2018?

Mike, (inaudible) for your question. Actually the consumption loan business is now becoming a key driver of the business and then continuing growing in gross billings is attributable to a number of things, one, acquisition of high-quality borrowers. And two is the repeat behavior of these borrowers. Remember in the slide, we showed our borrowers repeat on average 10 times in a 12-month period. And three, the low and grow effect, we now grow them at a much faster pace. The time they needed to triple the average size of the loan is now greatly shortened from previously 7 quarters, now to -- to 5 quarters, and it's becoming even shorter. So they are upgraded to higher loans at a faster pace, and then, when the loan amount is higher, generally, the long term is longer, which enabled us to charge a higher transaction fee. And then this is the low and grow model. So imagine, more and more borrowers on our platform will be pushed forwards to a more matured stage. Particularly, when they have crossed the breakeven threshold and go more and more towards the maturity, and at that time, they repeat at the larger size and pay slightly higher transaction fees to allow us generate recurring revenue. So that's the trajectory, the driver to the trajectory. In terms of 2018, we are not giving any guidance at this -- as of this moment, and I hope the business -- what you're seeing -- the business, the third quarter will differentiate, and we also said in the fourth quarter, we will be able to break even the entire business and achieve profitability. Hope that answers your question.

This concludes our question-and-answer session. I would like to turn the conference back over to Kerry Shen.

Hi, everybody. Thank you for participating in our third quarter earnings call. If there are no further questions, let me turn to Dr. Zane Wang for closing remarks.

Thanks, Kerry. We believe the strong results we achieved in the third quarter have brought us another step closer towards the fulfill the lifetime consumer credit needs of China's 500 million EMMA consumers. Looking ahead, we remain committed to our low and grow model, which features these characteristics: first, loyal, high-quality borrowers who borrow again, again at increasing amounts over extended period of time. Second, highly favorable and the improving CAC to lifetime value ratio and diversified acquisition channels and a lender base. And then the customer lifetime value and the growing recurring revenues. All this are tied up to our low and grow model. So thank you, everyone, for joining us today. We're grateful for the long-term support of our shareholders and look forward to speaking with you soon. Thank you.

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