Cango Inc. Q3 FY2022 Earnings Call

Good morning and good evening, everyone. Welcome to the Cango, Inc.'s Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. This call is also being broadcast live on the company's IR website. Joining us today are Mr. Jiayuan Lin, Chief Executive Officer, and Mr. Yong Yi Zhang, Chief Financial Officer of the company. Following Management's prepared remarks, we will conduct the Q&A session. Before we begin, I refer you to the Safe Harbor statement in the company's earnings release, which also applies to the conference call today as management will make forward-looking statements. With that said, I'm now turning the call over to Mr. Jiayuan Lin, CEO of Cango. Please go ahead, sir.

Hello everyone and welcome to Cango's third quarter 2022 earnings call. In the third quarter, market conditions in China's automotive industry have remained tough due to COVID-19 resurgences and a complex external environment. However, the pandemic has changed consumer behavior, with a shift towards online shopping that is transforming the entire automotive industry transaction model. Additionally, new policies introduced in the last two quarters have boosted confidence among industry players and improved the industry's order, establishing a solid foundation for the sustainable growth of China's automotive sector. We stayed focused on our car trading transaction business during this quarter and continued to implement our dual platform strategy, catering to both new and used car markets. We have enhanced our service capabilities and increased our supply chain engagement through standardization, utilizing over a decade of industry experience, in-depth insights into lower-tier markets, and excellent supply chain support. Moreover, we are empowering medium to small-sized dealers with high-margin products, further solidifying our platform's role in customer acquisition and service delivery. Our operational performance was strong in the third quarter, with total revenues reaching RMB 420 million, where approximately RMB 350 million came from car trading transactions, accounting for over 83% of our total revenues. Next, I would like to highlight some key aspects of our third-quarter business performance. Starting with our new car trading transactions, we expanded our vehicle inventory and diversified by brand and model. Our negotiations with major OEMs such as GAC Mitsubishi, FAW Volkswagen, and FAW Audi have progressed well. More OEMs are starting to recognize our industry expertise and full-service capabilities in auto transactions, especially in lower-tier markets. Additionally, we have improved our team's skills in evaluating car models and prices, enabling us to increase our vehicle diversity and better align our stock with local demand, thus enhancing our competitive edge. Regarding our transaction facilitation services, we continue to develop and commercialize solutions to meet dealer needs, focusing on standardization. We launched new payment functions and products to enhance dealer experiences on our platform, increasing their engagement. Our Cango Haoche Platform has seen steady growth, with 9,350 dealers across 31 provinces and 305 cities as of September 30, 2022. Our inventory on the platform currently includes 43 vehicle models from 23 brands, and we have sold a total of 12,639 cars in the first nine months of 2022, with over 7,600 being new energy vehicles, resulting in an EV penetration rate exceeding 60%. In addition to maintaining a steady supply of high-quality new cars, we are refining our online offerings for dealers. In October, we launched several key standardized products, including deposit guarantees and hassle-free vehicle replacements, which have encouraged an uptick in dealer activity and contributed to new online transaction behaviors on our platform. In the third quarter, the total number of car sources posted and search entries increased more than fourfold quarter-over-quarter to nearly 10,000. Additionally, since launching the Cango Haoche app at the end of the second quarter, it has received over 300,000 pageviews and more than 27,000 unique visitors by the end of September. We also integrated a one-click connection to our aftermarket and automotive financing facilitation services on the app, allowing dealers to easily access our high-quality services. We addressed dealers’ various insurance needs with a comprehensive mix of industry insurance products focused on auto insurance and customized non-auto insurance options. However, we observed a slight increase in overdue ratios quarter-over-quarter due to pandemic outbreaks. While the outlook remains cautious, we plan to tighten risk controls and strengthen post-management to maintain our overdue ratio within a safe range. The pandemic has created significant volatility and uncertainty in China's auto market, and we are working to build a new digital supply chain through the Cango Haoche platform to offer solutions for dealers regarding car sourcing, logistics, and vehicle trading. This technology-driven platform can significantly enhance dealers' operational models and reduce traditional constraints in capital, logistics, and inventory while fostering the digitization of the automotive market. Now, moving on to our advancements in the used car transaction business, we have officially launched our Cango U-Car WeChat mini program to provide dealers with more convenient used car services. By the end of the third quarter, it garnered over 290,000 pageviews and 15,000 unique visitors with more than 3,000 registered dealers. Our self-owned used car model is a key strength of Cango U-Car, supported by our extensive dealer network in lower-tier cities, giving us access to a wealth of high-quality used cars, including those replaced by financing customers, repossessed vehicles, and wholesale offerings from OEM partners. Our self-owned car model offers strong user engagement and manageable risks, leading us to prioritize this model moving forward. Cango U-Car’s competitive edge lies in our high-quality used car sources and personalized matching services, significantly enhancing the trading experience and efficiency for dealers. The interest in our WeChat mini program has prompted us to develop a web version of Cango U-Car, expected to launch in the coming year, which will provide even more comprehensive services. Looking ahead in the used car market, recent favorable policies have revitalized sales. In early July, 17 government departments announced measures to streamline used car trading, including the lifting of restrictions on cross-regional transfers of vehicles meeting national emissions standards starting August 1, and allowing temporary ownership registration for dealers from October 1. These changes will shift competition in the used car sector towards quality, service, and consumer protection. The used car market is vital for the overall car market’s circulation; by removing barriers to used car sales, we can positively impact new car sales as well. Hence, promoting the healthy development of the used car sector is crucial for new car sales growth. In summary, Cango U-Car is a strategic component of our development plans. We believe that leveraging our industry expertise and established network will enable us to seize opportunities in the used car market while delivering better products and services to dealers. By serving dealers directly, Cango Haoche can also bring high-quality vehicles and standardized services to our wider user base in lower-tier markets. In the near future, we anticipate ongoing COVID-19 outbreaks and a complex global economic landscape to keep presenting uncertainties in China's automotive sector. In light of this scenario, we will remain cautious, keeping our long-term vision in focus. We aim to leverage our strengths to advance both new and used car businesses in parallel while enhancing our one-stop platform services to create value for OEMs and dealers and make car purchases a seamless and enjoyable experience. Now, I will hand the call over to our Chief Financial Officer, Michael Zhang, for an overview of the company's financial performance.

Thanks, Jiayuan. Hello everyone and welcome to our third quarter 2022 earnings call. Before I start to review our financials, please note that unless otherwise stated, all numbers are in RMB terms and all percentage comparisons are on a year-over-year basis. Our third quarter performance showcased the resilience and strength of our car trading transaction business even in a challenging environment. We recorded a total revenue of 416.4 million, outperforming our previous guidance. Car trading transaction business delivered revenues of 347.2 million, continuing to play an essential role in our platform. Now let's move on to our costs and expenses during the quarter. Total operating costs and expenses in the third quarter 2022 were 608.8 million compared to 839.6 million in the same period of 2021. Cost of revenue in the third quarter 2022 decreased to 388.7 million from 610.5 million in the same period of 2021. As a percentage, our total cost of revenue in the third quarter 2022 was 93.3% compared with 76.3% in the same period of 2021. The change was primarily due to an increase in car trading transaction share of total revenues. Sales and marketing expense in the third quarter of 2022 decreased to 17.9 million from 46.8 million in the same period of 2021. As a percentage of total revenue, sales and marketing expenses in the third quarter 2022 was 4.3% compared with 5.8% in the same period of 2021. General and administrative expenses in the third quarter 2022 decreased to 57.8 million from 64 million in the same period of 2021. As a percentage of total revenue, general and administrative expenses in the third quarter 2022 was 13.9% compared with 8% in the same period of 2021. Research and development expenses in the third quarter 2022 decreased to 10.2 million from 17.4 million in the same period of 2021. As a percentage of total revenue, research and development expenses in the third quarter 2022 was 2.4% compared with 2.2% in the same period of 2021. Net loss on risk assurance liability in the third quarter 2022 was 85 million compared with 55.5 million in the same period of 2021. Net loss on risk assurance liability was mainly due to a sequential increase in the default rate since 2021. We recorded a loss from operations of 192.3 million in the third quarter 2022 compared with 39 million in the same period of 2021. Net loss in the third quarter of 2022 was 130.3 million; non-GAAP adjusted net loss in the third quarter 2022 was 110 million. On a per share basis, diluted net loss per ADS in the third quarter 2022 was 0.96 and diluted non-GAAP adjusted net loss per ADS in the same period was 0.81. Moving on to our balance sheet, as of September 30, 2022, we had cash and cash equivalents of 745 million compared with 1,250.7 million as of June 30, 2022. As of September 30, 2022, the company had short-term investments of 2.7 billion compared with 2.1 billion as of June 30, 2022. Looking ahead to the fourth quarter 2022, we predict our total revenue to be between 450 million and 500 million. Please note that this forecast reflects our current and preliminary view on the market and operational conditions, which are subject to change. This concludes our prepared remarks. Operator, we are now ready to take questions.

We have our first question from Shelley Wang with Morgan Stanley. Please go ahead.

Hi, I'm Shelly from Morgan Stanley. I have three questions. The first question is about your outlook for the 2023 car market, as we expect some reopening policies for China in the coming months due to the gradual release of restrictions. What is your outlook for the 2023 China auto market? The second question is about the progress of your transformation. When do you anticipate completing the transformation process, and when do you expect to breakeven? The third question concerns the used car market. We are noticing numerous favorable government policies regarding used cars. What are your expectations for the used car business, and what specific initiatives are you planning to implement to enhance the used car market?

Thank you, Shelley. I will address your three questions. Regarding the outlook for the 2023 car market, on the supply side, OEMs are introducing a range of new car models, providing consumers with more options and boosting car consumption across various demographics and market segments. However, ongoing chip shortages and lengthy production cycles are leading to reductions in production, which will keep overall production capacity in the automotive market under pressure. On the demand side, consumption is likely to stay weak due to the ongoing effects of the pandemic. Consumer purchasing behavior next year will significantly depend on pandemic management and their outlook on its development. As for your second question about our transformation program, we have gradually rolled out standardized products on the Cango Haoche app, including reliable car search, logistics services, deposit guarantees, insurance, and customer lead generation services. As dealers trial these products, we have been refining them to improve user experience. Additionally, based on our new car transaction business model, we have confirmed the viability of our used car business and are allocating resources to develop a transaction platform for used cars, which we aim to launch by year-end. Over time, the validation of our entire transaction platform demonstrates the business viability supported by our processes. Our infrastructure and backend IT operations are fully established, and we are starting in-depth collaborations with major OEMs. According to our data, revenues from car trading transactions now represent about 80% of our total revenues, indicating that our transition to a car transaction platform is effectively complete. The next milestone will be scaling up our business model, which we aim to complete next year while continuously enhancing its replicability, sustainability, and profitability. Regarding your third question on the used car market, while this market is rapidly growing, first, the government is increasingly focusing on it, as shown by a series of documents published by the Ministry of Commerce to promote the development of the used car segment. Second, the rising number of used cars will result in a larger pool of used cars in the future. Thus, we believe the used car market will continue to expand for a considerable time. Thank you. That's all from me.

Your next question comes from Sophia Xu with Goldman Sachs. Please go ahead.

Thank you. I have two questions. The first question concerns automotive financing facilitation. Based on the data, the company's incremental revenue from car loans is currently very small. Does this indicate that you plan to completely stop the lease business? What is the reasoning behind this decision? Additionally, I want to ask about the overdue ratio, which continues to grow. When do you anticipate an inflection point, meaning when do you expect the overdue ratio to start declining? My second question is about the dealership network. You previously mentioned that the company serves nearly 50,000 dealers in lower-tier markets. What size do you expect the dealer network to reach, and what will be the expected market share?

Thank you. I will address your two questions. The first question pertains to our automotive financing facilitation business. Given the current macroeconomic conditions, expanding this business may lead to fluctuations in our default rates, which could create significant cash flow pressures and potentially threaten the company's survival. As a result, while we are not entirely abandoning the automotive financing facilitation business, we have been proactively reducing its size. We have integrated these auto financing facilitation services into our Haoche app. In the third quarter, our overdue ratios increased slightly due to the pandemic's impact. Based on our current business development strategy, we expect the overdue ratios to remain at this level for some time as the existing loans are settled. However, the overdue ratios will not reach zero, and we do not foresee an inflection point. Regarding your second question about our dealership network in lower-tier markets, our platform currently has around 12,000 dealers, encompassing both new and used car dealers. At this time, we are concentrating on encouraging dealers to migrate to our platform through promotions and fostering their reliance on our app, which we believe will enhance our app’s functionality and user experience, allowing us to offer better services to our dealers. Thank you.

Your next question comes from Brian Lantier with Zacks. Please go ahead.

Good evening, gentlemen. Thank you so much for holding this call. It's nice to see a little bit of stabilization in the business. I think that's good news. The first question I guess is sort of big picture, ways to increase shareholder value for the company. You obviously had the two special dividends this year and you still have an incredibly strong balance sheet. Looking out, how does the company prioritize that at the management and board level, where are your preferences to try and drive shareholder value investments in R&D, share buybacks, additional dividends, or perhaps even acquisitions in the future? Do you have an internal preference among those? And then secondly, we're hearing after the third quarter from a lot of the Chinese auto manufacturers that they're ramping up production, but we're hearing that dealers sell-through is going a little bit lower. So we're hearing about some inventory build at the dealer level. I'm wondering how you think that could impact 2023 if there is excess inventory on dealer lots. Thank you.

Thank you, Brian. I'll address your two questions. The first question is about our capital allocation. We have always prioritized maximizing shareholder value, and all decisions regarding our capital allocation are made with careful consideration. We don't have specific preferences; we distributed dividends twice this year and continue our share buyback program. Our investments in research and development are aligned with our business development plans, and we will consider opportunities as they arise. Our approach to cash deployment is strategic, taking into account our business position, model development, expenditure programs, and external opportunities. Your second question concerns the inventory build-up and market demand. Due to the pandemic, consumer uncertainty about future income has led to a decline in car demand when comparing forecasted and actual figures. We need to see if this pent-up demand materializes in the future, and we are closely monitoring the situation. Importantly, consumer demand for electric vehicles is clearly increasing. Although some internal combustion engine cars are becoming cheaper, consumers still prefer EVs over ICE cars, leading to a decline in demand for traditional ICE vehicles. Thank you.

The next question comes from an analyst with Citi. Please go ahead.

Thank you. I have two questions. The first is regarding the new partnerships with several traditional OEMs mentioned earlier by Mr. Lin. What makes these OEMs choose to collaborate with Cango, and what are the company's competitive advantages? My second question pertains to the Cango U-Car. You noted that self-owned used cars are an advantage for Cango U-Car, so does the company intend to develop Cango U-Car into a fully self-owned car platform?

Thank you very much. I appreciate your two questions. Earlier, I met with several OEMs, and all of them recognized our competitive advantages. Over the decades, we have been serving small and medium-sized dealers in lower-tier markets. Thanks to our hard work, we have built strong auto sales expertise in these markets, and the major OEMs have acknowledged our capabilities and penetration in lower-tier markets. They hope to leverage our network in these areas to sell their vehicles. In addition to selling vehicles, we also provide a wide range of services including warehousing, logistics, delivery, financing facilitation, and insurance. We can customize our services to dealers based on their specific needs and geographical locations. Such service capabilities are unique in the lower-tier markets, differentiating us from our competitors and have been widely recognized by both OEMs and dealers. Regarding your second question, a purely self-owned model will be asset-heavy and requires significant cash flow and investment, which is definitely not what we want. Right now, we want to validate our business logic through the self-owned model to attract more dealers so we can build a used car transaction platform called Cango U-Car. Then we will address these challenges and enhance used car efficiency with our platform. The self-owned model will be one of our models rather than the only one. Thank you.

We have no further questions at this time. I'll now hand back to management for closing remarks.

Thank you very much. That concludes today's earnings call.