Hello, and welcome to the X Financial Second Quarter 2019 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to your host today, Jennifer Zhang. Please go ahead, ma'am..

Thank you, operator. Hello, everyone, and thank you for joining us today. The company's results were released earlier today and are available on the company's IR website at ir.xiaoyinggroup.com. On the call today from X Financial are Mr. Justin Tang, Founder, Chairman and CEO; Mr. Simon Cheng, President; and Mr. Kevin Zhang, CFO. Mr. Tang and Mr.

Cheng will give a brief overview of the company's business operations followed by Mr. Zhang, who will go through the financials. They are all available to answer your questions during the QA session.

I remind you that this call may contain forward-looking statements under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.

Such statements are based on management's current expectations and current market and operating conditions and relate to events that involve known or unknown risks, uncertainties and other factors, all of which are difficult to predict and many of which are beyond the company's control, which may cause the company's actual results, performance or achievements to differ materially from those in the forward-looking statements.

Further information regarding these and other risks, uncertainties and factors is included in the company's filings with the U.S. Securities and Exchange Commission. The company does not undertake any obligation to update any forward-looking statements as a result of new information, future events or otherwise, except as required under law.

It is now my pleasure to introduce Mr. Justin Tang, Mr. Tang. Please go ahead..

Thank you, Jennifer. Hello, everyone. We are pleased to report a solid quarter, where we made significant progress across a number of different aspects. Our business momentum remains strong with quality of loans facilitated on our platform improving slightly and funding from the institutional investors expanding.

I'd like to highlight some of these achievements. First, the industry regulatory environment is still challenging during the second quarter of this year.

No matter what the regulator -- regulation trends are, we are making ourselves thoroughly prepared to be qualified and in compliant with the new regulation in order to protect investors' and shareholders' benefits.

The P2P industry continues undergoing so-called check and audit process per regulator's requirements, and we are complying with regulators' so-called "suite decline" requirements by decreasing our loan balance and the number of active lenders.

There are a few potential outcomes for the P2P industry, but at this moment, it remains unclear, so we are not sure if the so-called registration will ever be completed. At the same time, we are working with local regulators to explore the possibility to transform part of our business into a microcredit loan company.

Second, the high-quality loans on our platform and our strong reputation are helping us to attract more institutional investors. During the second quarter of 2019, funding from non-individual investors accounts for around 26.7% of the loans facilitated through our platform, a significant improvement from 10.4% in the first quarter.

Demand from institutional investors for our high-quality assets remains strong and will gradually reduce our funding costs over time.

Financial institutions have extended credit lines to us in an amount of approximately RMB 26.4 billion for us to facilitate loan transactions on our platform, which reflects the trust that financial institutions have in the quality of our assets and the strength of our risk management.

So, we are pretty confident that if necessary, we can use the institutional funding to maintain the stable growth of our business without any interruption. Third, our delinquency rate improved on a sequential basis as we continue to invest in our risk management systems and the technology.

We are diverse by our customer acquisition channel as well through a partnership with e-commerce platforms and other channels with better customer quality.

Lastly, Xiaoying Wallet, our recently launched revolving credit product, grew rapidly during this quarter, with transaction volumes jumping significantly to RMB 970 million from RMB 200 million in the last quarter, and outstanding loan balance increased to RMB 578 million as of June 30, 2019 from RMB 177 million as of March 31, 2019.

Xiaoying Wallet was developed with the needs of our customers in mind, and we leveraged our sophisticated big data analysis capabilities and advanced technology infrastructure to offer the best product in the industry.

In conclusion, we are confident in our future growth prospects and ability to create long-term value for our investors and shareholders. We will continue to provide the best user-friendly and convenient financial services to borrowers and help them meet demand for consumption and grow our online consumer lending business.

This will conclude my remarks. Now, I'll turn it over to Simon Cheng, our President..

Thank you, Justin. Hello, everyone. We are very pleased to see the quality of our loans has improved and delinquency rates for both 30-90 days and 90-180 days went down sequentially, which reflects our strong risk management capabilities.

Since late 2018, we have taken a prudent approach in our credit policies, and it is very good you see stable and improved credit quality during this uncertain macro environment. We will continue our prudent approach in our credit policies in the later part of 2019.

Besides, we have expanded our funding channels to banks, trust companies, and other financial institutions, which further strengthens our funding costs and diversifies our funding sources. In addition to that, we are expanding our borrower base by cooperating with other fintech companies.

We are very happy to see Xiaoying Wallet, our recurring consumption product, is growing in the importance of our business as a result of strong demand in the market. As Justin has mentioned, the number of transactions of Xiaoying Wallet in the second quarter increased by 347% quarter over quarter.

The number of registered and approved users of Xiaoying Wallet was 542,752 as of June 30, 2019, increasing from 192,891 as of March 31. Xiaoying Wallet expects to maintain strong growth momentum and gradually account for a large percentage of our overall business.

We are very confident we will continue to deliver good results going forward in the challenging environment. I will turn the call to Kevin, who will go through our financials..

Thank you, Simon. We delivered solid financial results during 2019 second quarter despite the regulatory uncertainties that remain, and the non-GAAP net income attributable to X Financial shareholders increased to RMB 342.5 million during this quarter, a 57% increase compared to our results in the first quarter.

We continue to expand our relationships with banks and trust companies, as well as other institutional funding partners. 26.7% of our funding in the second quarter is from the non-individual investors, and we expect 45% and over 60% of the funding will be supported by non-individual investors in the third and fourth quarters respectively.

The overall funding cost remained stable, while we foresee a decreased funding cost from financial institutions in the second half of the year of 2019, as low as 8% annually. In the interests of time, I will not walk through every detailed line. Please refer to our earnings release for further details.

Net revenues in the second quarter of 2019 were RMB 810 million, a 4.2% increase quarter over quarter. The revenue fixed rate is 7.96%, actually a 0.1% decrease compared to the revenue fixed rate in the fourth quarter, since the product mix is relatively stable and the APR of our main product -- car loans -- remains unchanged.

The origination and service expense as a percentage of loan volumes facilitated increased by 0.65% from 3.5% in Q1 to 4.15% in Q2, primarily due to an increase in consumer operating cost for the recently launched revolving credit product, Xiaoying Wallet.

We are pleased to see one of our major subsidiaries classified as a software enterprise in May 2019, which makes it fully tax exempt of Enterprise Income Tax of 2019 and subject to a preferential EIT tax rate of 12.5% from 2019 to 2021.

This contributed significantly to our income tax benefit of RMB 114 million during this quarter, and we expect that the effective tax rate will be around 15% in 2019, a 45% decrease compared to 2018. Besides, we expect loan facilitation for the third quarter of 2019 to be approximately RMB 10.5 billion.

This forecasts reflects the company's current and preliminary views, which are subject to change.

In conclusion, we are pleased with our operational and financial performance this quarter and will continue to roll out initiatives and apply technology across our business to improve operational efficiency and create long-term sustainable value for our shareholders.

Now, this concludes our prepared remarks, and we would like to open the call to questions. Operator, please..

Yes, thank you. We will now begin the question and answer session. [Operator Instructions] And the first question comes from John Cai with Morgan Stanley..

Hi. Thank you, management, for taking my questions. I have a few questions, and the first one is on the regulations. Can you talk about what's the latest communications with the regulators? What are the expectations on the pace of the three decline? And also, Mr.

Tang mentioned that you were talking about transit in some of the business to a microcredit online lending license, so just wondering if there's any context or further details on that front? How many portions will go there, and when do we expect the license to be resumed? Because you were suspended. And, the second question is about the growth.

Actually, we mentioned that the risk has improved sequentially, and we also have over RMB 20 billion institutional funding on standby, so I'm just wondering what kind of loan balance growth can we expect for the second half for this year. And, the third question is on the product. I think we have seen very strong momentum of the Xiaoying Wallet.

Based on my calculation, the ticket size seems to be very small, at around RMB 300-400.

Can the management also share some take rates on tender and profit contribution of this product -- in particular, in relation to the customer acquisition cost? Because I also see that the origination and service costs have increased, so I just wonder if we look at this Xiaoying Wallet stand-alone, can they break even after the customer acquisition costs, and what sort of profit contributions do we expect in the future? Thank you very much..

John, thanks. So, I will address the first and second questions, and Simon and Kevin can answer the third question. In terms of regulation, like I mentioned in the call, at this moment, the prospect of the registration remains unclear.

Basically, we are working with local regulators who require us to decrease our loan balance on our P2P platform and also decrease the number of active lenders, and we are complying with that.

At this moment, all of our RMB 20 billion loan balance -- we have just over 60%, just under 65%, in our P2P platform, and we have declined by around RMB 500-800 million every month. We'll go ahead with this registration process, but we don't know yet.

At the same time, we are working with regulators to explore the possibility of transforming part of our business into a microcredit company. We need to work together between the local regulators and the [indiscernible] regulator, so we are working pretty actively with them, and if and when it'll happen, we don't know yet.

But again, we are pretty well prepared in all fronts, and no matter how the regulation will go, we'll be able to maintain the scale of our business without much interruption. So, the second, in terms of growth prospects, we gave guidance for the third quarter. You see our second quarter, we had some small, sequential growth from the quarter.

I think in Q3, it was down further sequential growth in Q2 in the single digits, and I think Q4 will be that as well. At this moment, we're only giving visibility for the second half of this year.

We just don't want to make a premature prediction for the business next year because the external economic environment is still fairly uncertain and the general credit environment is still very challenging. But, the funding is not a bottleneck at all. We actually have sufficient funding to support the growth of our business.

I think the key, really, is to acquire the quality loan demand. We are very careful in terms of who will facilitate and the quality of their loan demand. Kevin and Simon can answer the Wallet question now..

Yes. Xiaoying Wallet is a recurring consumption product, so the customer is supposed to use the product very frequently and with a lot of transactions. That's why our general transaction size is about RMB 300-400.

This is a small-digit transaction by the customer, who will continue to use it for a longer time, which means a longer lifetime for the customer because it's a consumption loan, and it also has better credit quality, and also, because it lasts for quite a long time, then our revenue source will be quite diversified.

It's not only from the interest income. So, with all the strong benefits from this product feature, actually, currently, we are trying to increase the volume of these active frequent consumption users for our product.

We see very strong demand in the market, we see very strong growth in the future, so our focus right now is not a probability, but given the data we have, we expect that the customer we've acquired can generate positive revenue after a year..

I will give some more details about this product after Simon. Actually, when we're talking about Xiaoying Wallet, we are categorized for three sub-segments. One is consumption, the second we call a kind of installment, and the third will be a cash advance.

For about 2.8 million transactions of all the Xiaoying Wallet product, about 2.7 million will be the consumption. The ticket size for the consumption is only about, as Simon mentioned, RMB 200-300 per transaction. But, when we're talking about the installment and the cash advance, it will be around RMB 1,000-3,000 per transaction.

For the consumption, it's just like we use our credit card, to purchase something we can't afford. So, we will provide around a seven-day grace period. The tender for the consumption will be very short, but when we're talking about installment and cash advance, it will be around seven to nine months, similar to our car loan products.

As we know, the recurring products usually have a longer use life compared to our loan products, so for the first several months, we usually like to invest more on our customer acquisition cost.

That means for the first several months, we expect that will be an operating loss for the segment, but after one to two years of operation, we expect the total business will be break-even..

Thank you. Can I have a follow-up on the customer acquisition cost? So, I just wondered what's the trend and what's the cost we are paying for every Xiaoying Wallet customer, and a new question, actually, is about our cooperation with ZhongAn.

What's the mix at the moment, what's the cost, and any new partners we are working with? Thank you very much..

I will give some color first, and then maybe Simon and Justin can help you. When we're talking about customer acquisition cost, we now plan to invest about RMB 150-200 to acquire a new, active customer for the Xiaoying Wallet. We expect the average acquisition cost will remain stable in the second half of 2019.

That's our foreseeable view for the customer acquisition cost for the Xiaoying Wallet. When we're talking about our cooperation with ZhongAn, we now have only about 50% of our business worth now secured by ZhongAn Insurance. In Q1, it was about 82%. That [indiscernible] in this quarter was slightly improved.

And now, we are still seeking cooperation with other insurance companies and guarantee companies to increase the percentage of transactions supported by other partners, but we are still on the way. We do have a pipeline to negotiate about this..

As Kevin just said, ZhongAn is still our largest insurance partner at this moment, and have a very good relationship with ZhongAn, and at the same time, quarter by quarter, the loans insured by ZhongAn have decreased. We are actively seeking other partners, including insurance companies or some guarantee companies.

We have gotten a good response from their part as well. We will continue to diversify the guarantee partners for our business..

Thanks a lot. That's very helpful..

Thank you. And, the next question comes from Matthew Larson with National Securities..

Thank you, gentlemen, for taking my call. I got on the conference call a little late, so if I'm asking a question that you addressed, I apologize. You gave guidance in the earnings release for the third quarter.

Do you have guidance for the full year?.

Kevin, go ahead..

Actually, we foresee a very [indiscernible] in the fourth quarter. So, we're talking about the whole year, we'll take around RMB 40-41 billion loan facilitation amount for the whole year..

All right. So, it's reasonably flat, and that's because you're replacing your peer-to-peer funding with more institutional funding.

Is that why that's the case?.

That's a major driver because actually, we took a very prudent approach in our credit policy. At this moment, the environment is quite uncertain, so we really tried to make sure we have good quality for our assets, so we have a stable or slight increase in the plan at this moment..

And, by the end of the year, could you give me your goal as far as what percentage of your business will be institutionally funded?.

We expect by the end of this year, over 60% of our funding will be from financial institutions..

Was that 60% or 50%, did you say?.

60, six-zero..

Okay, all right. It seems to me that's what the regulators are pushing for, so that sounds like a majority and a big move up from where you were this time last year. Let me see.

Your stock, which came public at $14.00, is $2.60, trades well below book value, and the estimates I'm using -- maybe from my previous color, the Morgan Stanley analyst -- well, at this point, it looks like you're trading at two and a half times earnings, maybe thereabouts.

Is there any thought of a dividend or buying back some shares at this low level in addition to the other work you're doing?.

We made a $15 million dividend for fiscal year 2018. I think we will continue to make a dividend in 2019 as well. We have not done stock repurchase yet, and one of the reasons is the liquidity of our stock is fairly low, so it's pretty hard for us to buy much, and if we're buying, we will further reduce the liquidity in the open market.

It's not going to be good. The second, also, is because there are different possible outcomes for the regulation. We want to reserve some cash on hand in case we need to fund some financial institutions per regulatory requirement, so at this moment, we're just going to have a pretty stable dividend policy..

All right, that sounds good.

When do you expect to announce the dividend for '19?.

We do that once a year, so it will be after fiscal 2019 ends..

Oh, after fiscal '19 -- so, six months, at least. Okay.

Well, it looks like your business is humming along pretty well, and I guess the uncertainty is the regulatory rules that everybody's waiting for, but I would assume a well-capitalized firm like yourself with a large cash balance, which is trying to raise their institutional funding, would be one of the survivors in a business that is consolidating, and you would pick up market share at one point, so that's what I would be expecting.

Thank you. I appreciate it..

Thank you. We certainly think so..

Thank you. And, that is all the time we have for questions. I would like to return the floor to Jennifer Zhang for any closing comments..

Thank you, everyone, for joining us on the call today. If you haven't got a chance to raise your questions, we would be pleased to answer them through follow-up contacts. We look forward to speaking with you again in the near future. Thank you very much..

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