Futu Holdings Ltd Q2 FY2021 Earnings Call

Hello, ladies and gentlemen, welcome to Futu Holdings Second Quarter 2021 Conference Call. At this time, all participants are in a listen-only mode. After the management's prepared remarks, there will be a Q&A session. Today's conference call is being recorded. If you have any objections, you may disconnect at this time. I would now like to turn the conference over to your host for today's conference call, Daniel Yuan, Chief of Staff and Head of IR at Futu. Please go ahead, sir.

Thanks, operator, and thank you for joining us today to discuss our second quarter 2021 earnings results. Joining me on the call today are Mr. Leaf Li, Chairman and Chief Executive Officer; Arthur Chen, Chief Financial Officer; and Robin Xu, Senior Vice President. As a reminder, today's call may include forward-looking statements, which represent the company's belief regarding future events, which by their nature are not certain and are outside of the company's control. Forward-looking statements involve inherent risk and uncertainty. We caution you that a number of important factors could cause actual results to differ materially from those contained in any forward-looking statements. For more information about the potential risks and uncertainties, please refer to the company's filings with the SEC, including its registration statement. So, with that, I will now turn the call over to Leaf. Leaf will make his comments in Chinese and I will translate.

Hello, everyone, thank you for joining the earnings call today. We reached a significant milestone of 1 million paying clients by the end of the second quarter, marking a 230% increase compared to last year. We added 211,000 clients, making it our second-best quarter ever. Our continuous focus on providing an exceptional user experience and strong brand image has led to another quarter of significant growth in our client base, with over 50% of our new paying clients acquired organically and a high retention rate of 97.8%. Moving forward, our primary growth strategies will be to maintain and expand our leadership position in Hong Kong, increase our market share in Singapore, and enhance self-clearing in the U.S. to boost monetization and operational flexibility. In the second quarter, Singapore accounted for nearly half of our new paying clients, presenting a significant opportunity for us. We plan to utilize marketing and word-of-mouth to enhance our presence. In the U.S., our self-clearing efforts have gained momentum as we have successfully migrated around 350 U.S. stocks to our clearing system, with a goal of self-clearing 50% of U.S. stocks by year-end. Our total client assets reached HK$503 billion at the end of the quarter, reflecting a 253% year-over-year growth and 9% quarter-over-quarter growth, despite some market challenges. The average client assets decreased to HK$503,000 as we increased acquisition in new markets. Total trading volume rose 104% year-over-year to HK$1.3 trillion, with U.S. trading making up about 64% of the total. Trading volume decreased from the first quarter due to a lower turnover rate across various markets and clients. We have observed that clients are more cautious in the current market conditions, and we anticipate that future trading volume growth will primarily come from an increase in client accounts and assets rather than turnover if the market environment remains the same. Our wealth management division, Money Plus, has shown resilience during the market downturn, although Hong Kong IPOs at the end of the quarter affected some of the assets we gained. We expect our asset balances to grow steadily in the upcoming quarters. As of June 30th, over 74,000 clients were involved in wealth management, with total assets reaching HK$13.8 billion, up 59% year-over-year and 5% quarter-over-quarter. Money Plus formed new partnerships with seven prominent asset managers this quarter, including Goldman Sachs, UBS, and Principal. We also became the exclusive distributor of the ChinaAMC Select Greater China Technology Fund, the only technology-focused mutual fund related to China in Hong Kong. We’re continuously innovating product features, having introduced a fund portfolio rebalancing function and enhanced the money market fund capabilities, allowing clients to automatically manage their subscriptions and redemptions based on their cash and margin balance. Our enterprise business, Futu I&E, serves 186 IPO and IR clients and 263 ESOP solutions clients as of the end of the quarter, showing year-over-year growth of 181% and 153%, respectively. We are enhancing our ESOP business’s value by offering a comprehensive solution with various added services for the management team and employees of our corporate clients. Our experience managing ESOP grants across various regions helps us attract large corporate clients. While we are seeing low attrition rates among paying clients, we are encouraged by strong user engagement data, with average daily active users consistently above 1 million and an average time spent by users of about 30 minutes on trading days in June. To further drive engagement, we continue to enrich our social community content by attracting diverse stakeholders and improving our content recommendations. By the end of the quarter, over 600 companies had established enterprise accounts in our social community to engage with retail investors, providing essential data to aid in investment decisions. Next, I will turn the call over to our CFO, Arthur, to discuss our financial performance.

Thanks, Leaf and Daniel. Please allow me to walk you through our financial performance in the second quarter. All numbers are in Hong Kong dollar, unless otherwise noted. Total revenue was HK$1.78 billion, an increase of 129% from the second quarter of 2020 and a decrease of 28% sequentially. Brokerage commission handling charge income was HK$798 million, up 95% year-over-year and down 40% quarter-on-quarter. The quarter-on-quarter decline was mainly due to a sharp drop in trading turnover amid general market sentiment from about six times in the first quarter to three times in the second quarter, respectively. This was partially offset by higher client assets and a slightly sequential uptick in blended commission rate to 6.1 basis points. Interest income was HK$610 million, an increase of 194% year-over-year and a decrease of 7% quarter-on-quarter. The year-over-year increase in interest income was mainly driven by higher margin financing balance, higher security borrowing, and the lending service income, as well as higher IPO financing income. The moderate quarterly decline can be mainly attributed to a reduction in security borrowing income as the market value of U.S. stock borrowing and the borrowing rate both dropped sequentially. Other income was HK$169 million, up 141% year-over-year and down 24% quarter-on-quarter. The year-over-year growth and the quarter-on-quarter decline can both be attributed to changes in our IPO subscription service charge income and currency exchange service income as market conditions fluctuated. In terms of cost, our total cost was HK$279 million, an increase of 81% from the same quarter last year and a decrease of 37% from last quarter. Brokerage commission and handling charge expenses were HK$145 million, an increase of 89% year-over-year. This increase was roughly in line with the changes of our brokerage commission and handling charge income. Interest expenses were HK$80 million, up 98% year-over-year. The growth was primarily due to higher costs associated with our security borrowing and lending business and higher margin financing interest expenses driven by higher margin financing balance, partially offset by lower cost of funding. Processing and servicing costs were HK$54 million, up 48% year-over-year. The increase was primarily due to the increase in cloud service fees to process a higher number of concurrent trades. As a result, total gross profit was HK$1.3 billion, an increase of 143% from HK$534 million in the same period in 2020. Gross profit margin increased from 77.6% in the second quarter of 2020 to 82.3% this quarter, thanks to high operating leverage as a result of our larger business scale. Total operating expenses were up 145% year-over-year and 32% quarter-on-quarter to HK$647 million, over 40% of which was related to our international initiatives in Singapore and the U.S. markets. R&D expenses were HK$173 million, an increase of 48% year-over-year and 26% quarter-on-quarter, roughly in line with our R&D headcount increase. We continue to invest in our U.S. clearing capabilities and dedicated around 40% of our R&D personnel to further development in Singapore and in the U.S. to drive a smoother and customized product experience for local users. Selling and marketing expenses were HK$377 million, up 292% year-over-year and 37% quarter-on-quarter. The increase was primarily due to higher branding and marketing spending, especially in the international markets to cultivate brand image and acquire new clients. In the second quarter of 2021, over half of our marketing expenses were focused on overseas markets. G&A expenses were HK$97 million, an increase of 91% year-over-year and 24% quarter-on-quarter, due to an increase in headcount for general and administrative personnel. Our effective tax rate increased from 9% in the fourth quarter to 14.5% in the second quarter since our total tax credit arising from accumulated loss in the Mainland business has been fully utilized so far, and our net revenue derived from our U.S. stock trading declined in the second quarter. Going forward, we will expect our effective tax rate to be in the range of 12% to 14%. As a result, our net income for the quarter increased by 126% year-over-year and decreased by 54% quarter-on-quarter to HK$534 million. That concludes our prepared remarks. We would now like to open the call to questions. Operator, please go ahead.

Your first question comes from Katherine Liu of Morgan Stanley. Please ask your question.

I will translate for myself. I have two questions. First, can the management provide guidance on the third quarter-to-date results, including client acquisition pace, AUM per capita, turnover velocity, client acquisition cost, and possibly the growth rates of operating expenses? Second, considering the regulatory uncertainties surrounding restructured companies and ADRs, does the company have any plans for a Hong Kong listing? Thank you.

Thank you, Katherine. This is Arthur. I will take these two questions. First of all, just quarter-to-date, I just want to share some color. Definitely, I think the market fluctuations quarter-to-date have some negative impacts on our average client assets. So far in the wealth play, our average client assets will be down along in the range of 10% to 20%, mainly attributed to the markets and market loss, but we are very confident because even quarter-to-date almost every day we still see meaningful net asset inflows in terms of the wealth accumulation in Futu platforms. Therefore, as you think, if the market goes back to normal, since market loss or gain will come to the average numbers. And in terms of the clients’ trading velocity, we do expect trading velocity to have some rebound in July and August, given the market - especially high tax costs have meaningful setbacks, we do see some more transitions from the retail investors and unlike the situation in the second quarter, many investors set on the sidelines, we do see some participations in the third quarter. So based on the current run rate, I would expect in terms of top lines, we may see some sequential quarter-on-quarter increase in the third quarter compared with the second quarter. In terms of the client acquisition cost, I think on absolute amount levels, this marketing campaign spending will be roughly in line with what we gave in the second quarter, but definitely the client acquisition speed will slow down due to the market conditions. So this will affect the normal denominator numbers and then we will let our CAC numbers have a certain increase in the first quarter compared with the second quarter. For your second question, I think, number one, our BI structure is slightly different for many - compared with many Chinese ADR companies, because most of our revenue is now derived from offshore, essentially we do not generate any revenues from our BI structures. So even if there are some new regulations on the BI structure, I do not expect that we will have any meaningful operational or financial impact on our business. And definitely we have noted some recent trends in the capital markets and we are actively conducting quality research and valuation to sort things out. We will make a very comprehensive assessment to ensure that our decision maximizes our shareholders' long-term interests. Thank you.

Your next question comes from Ethan Wang from CLSA. Please ask your question.

Thank you, management. I have two questions regarding the risk of delisting for Chinese ADRs. First, can you provide insights on the current percentage of Chinese ADRs in relation to the total trading volume of U.S. stocks on Futu? Secondly, if delisting does occur for Chinese ADRs, these companies might switch their listings to Hong Kong, which would allow Chinese investors to trade these stocks through online brokers. Does this represent a significant risk for your firm, and how does management perceive this situation? Thank you.

Okay. Thank you. I would take the first question and I will leave my colleagues Robin and Leaf for the second question. In terms of our current U.S. stock trading, ADRs account for a very small part. If we do some back-testing, around 15% of our U.S. stock trading belongs to these Chinese ADRs. Robin or Leaf?

Thank you. I'll address the first question and leave the second one for my colleagues, Robin and Leaf. Regarding our current U.S. stock trading, ADRs make up a very small portion. Based on our back-testing, approximately 15% of our U.S. stock trading involves these Chinese ADRs. Robin or Leaf?

Yes. We think the return of Chinese ADRs back to Hong Kong could be a structural trend, although we don't really take a stance on how the regulations will evolve. The Hong Kong IPOs generally have very high monetization potentials. We generate a pretty sizable percentage of our revenue from the IPO subscription and margin financing interest. Additionally, in Hong Kong, there are more favorable trading hours for our clients. Also, just to add on to your other point about converting to primary listings, we don't think that onshore brokers will necessarily pose a great threat to our business. Many of the popular Chinese companies listed in Hong Kong are already accessible to our Mainland Chinese investors through Stock Connect, for example, Tencent. Some of these large-cap tech companies still account for a majority of our asset balance in Hong Kong. In comparison to trading through Stock Connect, trading directly in the Hong Kong market offers more flexible and favorable trading hours. For instance, if Mainland China has a public holiday, it does not affect our trading hours in Hong Kong, and there is a lot more flexibility because of our margin financing. Additionally, there are wider selection of stocks that investors can invest in. Therefore, we don't believe that the number of Chinese companies converting from secondary listings to primary listings will change our competitive edge in this market.

Sure. Got it. That's it for now. Thank you.

Mainland China's public holidays do not impact our trading hours in Hong Kong, offering us greater flexibility due to our margin financing. Moreover, investors have a wider range of stocks available for investment. As a result, we do not anticipate that the shift of Chinese companies from secondary to primary listings will alter our competitive position in this market.

Given that China has a public holiday, our trading hours in Hong Kong remain unaffected, and we have greater flexibility due to our margin financing. Moreover, there is a broader range of stocks available for investors. As a result, we do not think that the transition of Chinese companies from secondary listings to primary listings will impact our competitive advantage in this market.

Additionally, we also have a very differentiated client cohort compared to some of the onshore brokers, so we don't think our competitive advantage will be diluted should this circumstance actually come to fruition.

Your next question comes from the line of Zoey Zong from Jefferies. Please ask your question.

Hi, management. Thanks for taking my question. This is Zoey Zong from Jefferies, and I have two questions. My first question is regarding the tax rate. I believe we noted that the effective tax rate for Q2 was 14.5%, which is much higher than the previous quarter. I wonder what's the reason for the increase, and how should we estimate this number going forward? My second question is about the Hong Kong Exchange's plans to adopt a T+2 settlement cycle instead of the current T+5 in the first quarter of 2022. I was wondering how we should think about the impact on our IPO financing business. Thank you.

Thank you, Zoey. I will answer the first question and will leave the second question to Leaf. Actually, I had mentioned this in our opening remarks. You're right, our effective tax rate increased from 9% in the first quarter to 14.5% in the second quarter. The reason actually comes from twofold. Number one is our tax credit arising from historical accumulated losses in the China operation has been fully utilized. So this is a permanent effect. Secondly, our net revenue derived from our U.S. stock trading belonging to these Mainland individuals can make our offshore claims in Hong Kong, but you know their U.S. stock trading volume in the second quarter declined. Therefore, we have some temporary impact in the second quarter arising from these regions. Going forward, we expect our effective tax rate will be in the range of 12% to 14%. Thank you.

The losses in our China operation have been fully accounted for, resulting in a permanent effect. Additionally, the net revenue from U.S. stock trading by these Mainland individuals allows us to make claims offshore in Hong Kong. However, we did see a decline in their U.S. stock trading volume in the second quarter, leading to some temporary impacts from these regions. Looking ahead, we anticipate our effective tax rate will fall between 12% and 14%. Thank you.

Sure. So the IPO financing income accounted for about 4% of our revenue in the first half of this year, and the contribution was less than 6% in 2020. If we were to assume that the settlement period goes from T+5 to T+2, from a statistics point of view, this will only have about a 2% to 3% negative impact on our top line, which we think is manageable.

The effective tax rate will be in the range of 12% to 14%. Thank you. So the IPO financing income accounted for about 4% of our revenue in the first half of this year, and the contribution was less than 6% in 2020. If we assume that the settlement period changes from T+5 to T+2, statistically, this will have about a 2% to 3% negative impact on our top line, which we believe is manageable.

Additionally, we believe that the IPO subscription periods may overlap with each other. We believe some of the needs for IPO subscriptions have been subdued under the current regulations, and we think that could change after the reform. Especially when the markets are performing well and there are a lot of IPOs happening simultaneously, having a T+2 settlement period can increase the capital efficiency of our clients and therefore potentially help increase their engagement in this IPO subscription process. We also understand that the regulations are not only shortening the settlement period, but also may affect retail clients from subscribing to IPOs through multiple brokers. We believe that the IPO financing income constitutes a significant revenue stream for a lot of the mid- to small-sized brokers. Thus, this policy could actually contribute to industry consolidation and direct many of these retail investors to platforms like Futu, which offer a better user experience and more capital for them to utilize during IPOs.

Your next question comes from Hanyang Wang from 86 Research. Please go ahead and ask your question.

I will translate my questions. Thanks to management for addressing my questions. Congratulations on another excellent quarter. I have a question regarding the IPO business. Considering the uncertainties surrounding Chinese ADRs and the recent slowdown of Hong Kong IPOs, how will this affect our ESOP business, and will it also influence our user acquisition in Mainland China? Thank you.

Well, thank you. Let me take this question. I think, number one, the slowdown of Chinese companies overseas ADR IPOs is just a temporary situation. We understand that many Chinese companies are in the pipelines and are waiting for more clarity in terms of regulations from China and the U.S. regulators down the road. Therefore, I think the impact will be very short-term. Moreover, as Leaf mentioned before, we see more and more U.S. listed companies and pre-IPO companies considering Hong Kong as their primary listing stage rather than the U.S. in the past. We hold a very strong edge in the Hong Kong market, given that Hong Kong is our home base. Therefore, we believe our client position through ESOP and IPO will continue. Just to give you some breakdowns: in terms of our current client acquisition channels, organic already accounts for over 50%. If we just calculate the ESOP channel combined with this, we only account for around 10% of our total new paying clients every quarter. So I think the impact is manageable.

We have another question from the line of Katherine Liu from Morgan Stanley. Please ask your question.

I will translate for myself. I understand that your new market monetization may not be as crucial as your clients' market share, but I am curious if management has thought about increasing monetization in the Singapore market. Will there be any guidance or hints from the company, or will it be a natural outcome as client assets grow on the platform? Thank you.

Sure, Katherine. Let me give you some insights regarding our client profile in Singapore. I think in terms of age and their trading velocity, this population is very similar to what we see in Hong Kong markets. The average age is around 30 years old, and they do trade a lot, particularly for the U.S. markets. The average client assets in Singapore is around SGD6,000. Of course, this is relatively low compared with the assets we witness in China and Hong Kong, but encouragingly, if we look at the cohort basis, the new clients we acquired in March and April have cohort assets that are nearly double in the past four to five months. So, to answer your question, definitely we think the nature of our business is just like a rolling snowball. We are very happy to grow along with our clients in their investment journeys. We believe as time goes by, their average assets will become larger. Secondly, we will have more service offerings and product offerings in the pipeline. Hopefully, we will launch more businesses in the coming two quarters. For instance, we will provide Singapore clients with the opportunity to participate in the Hong Kong IPO retail tranche and expand our wealth management product offerings that are currently only available to Mainland and Hong Kong residents to include Singapore locals as well. Therefore, we believe as we provide more products and services, we will discover more monetization areas to enhance our average revenue per user.

As there are no further questions at this time, I would now like to hand the conference back to Daniel for closing remarks.

That concludes our call today. On behalf of the Futu management team, I would like to thank you for joining us today. If you have any further questions, please do not hesitate to contact me or any of our Investor Relations representatives. Thank you, and goodbye.

Thank you. That does conclude our conference for today. Thank you for participating. You may now all disconnect.