Earnings Call Transcript - FUTU Q3 2023

Operator, Operator

Hello, ladies and gentlemen. Welcome to Futu Holdings Third Quarter 2023 Conference Call. At this time, all participants are in a listen-only mode. After 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 to CEO and Head of IR at Futu. Please go ahead.

Daniel Yuan, Chief of Staff

Thanks, operator, and thank you for joining us today to discuss our third quarter 2023 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 the company's control. Forward-looking statements involve inherent risks and uncertainties. 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 Annual Report on Form 20-F. So, with that, I will now turn the call over to Leaf. Leaf will make his comments in Chinese, and I will translate.

Leaf Hua Li, Chairman and CEO

Thank you all for joining today. In the third quarter, we acquired approximately 65,000 paying clients, marking a 12% increase from the previous quarter. Our total number of paying clients reached 1.65 million, a 14% increase compared to the same period last year. As of now, we have surpassed our full-year target by acquiring more than 163,000 paying clients in the first three quarters of 2023. The Hong Kong market alone accounted for over 40% of our new paying clients in the third quarter. The surge in client acquisition was largely influenced by a relief rally in the first half of the quarter and effective marketing related to the government's Green Bond and Silver Bond issuances in the latter half. These two bond offerings drew allocation-focused clients to our platform. In late July, we launched our first offline store in Hong Kong to enhance brand recognition, support clients in opening accounts, showcase advanced product features, and answer questions about our products and services. This offline store successfully attracted middle-aged and senior clients, resulting in a lower customer acquisition cost. Notably, clients aged 55 and older made up over 50% of new paying clients acquired through the offline store during the quarter. In Singapore, we executed effective marketing campaigns for our cash management product, Cash Plus, leading to a 35% increase in paying clients year-over-year. We continue to see improvements in client quality in the U.S., as reflected in the growing net asset inflow from new paying clients. In September, we officially launched our brokerage services in Japan and Canada, providing clients with access to U.S. stock trading in Japan and both U.S. and Canadian stock trading in Canada. As we begin these market launches, our primary focus will be on refining the account opening process, expanding trading product offerings, and sharpening our brand positioning and marketing strategies. Despite varying sentiments across global equity markets, we achieved another quarter with a retention rate of over 98% for paying clients. We are also enhancing our trading product offerings in various markets. In Singapore, we introduced fractional shares for U.S. stocks and ETFs to improve accessibility for new investors. We enhanced our services for active options traders by implementing a multi-leg options rollover strategy in both Hong Kong and the U.S., allowing traders the flexibility to roll contracts nearing expiration to a later date at different strike prices. Total client assets increased by 27% year-over-year to HKD468 billion. Although the market downturn impacted the valuation of our clients' stock holdings, total client assets remained stable quarter-over-quarter due to strong net asset inflow. Importantly, total client assets in Singapore registered double-digit sequential growth for the fifth consecutive quarter, partly driven by improved asset quality. The average asset balance of new paying clients in Singapore was 20% higher than in the previous quarter. Trading volume surged in the third quarter, as clients traded more actively amid increased market volatility. Total trading volume rose by 14% from the previous quarter to HKD1.1 trillion, with U.S. stock trading representing about 75% of that total. The increased trading activity of the Magnificent Seven stocks resulted in a 19% quarter-over-quarter growth in U.S. stock trading volume. Hong Kong stock trading volume saw a 5% sequential increase, primarily due to heightened trading interest and leveraged and inverse ETFs. Margin financing and securities lending balances decreased by 4% from the last quarter as some clients reduced their positions in popular U.S. technology stocks. Total client assets in wealth management grew to HKD52 billion by the end of the quarter, reflecting a 100% increase year-over-year and a 19% increase quarter-over-quarter. In the third quarter, client assets in bonds grew by 87% sequentially, driven by the high yields of U.S. treasury bills. In Hong Kong, structured notes experienced strong demand from high-net-worth clients, who showed a lower risk appetite due to macroeconomic uncertainties. Consequently, the private fund balance increased by 52% quarter-over-quarter. In Singapore, total client assets in wealth management increased fivefold year-over-year, attributed to a tripling of wealth management clients and higher average asset balances. In the third quarter, we continued to widen our product offerings in Singapore by adding structured notes and SGS bonds. We had 391 IPO distribution and investor relations clients as of the end of the quarter, which is a 30% year-over-year increase. In the third quarter, we served as joint bookrunners for several prominent Hong Kong IPOs, including TUHU Car, 4Paradigm, and KEEP. Furthermore, we took part in every Hong Kong IPO for companies with a market capitalization exceeding HKD10 billion by the quarter's end. In the first three quarters, we underwrote 26 Hong Kong IPOs, ranking first among all brokers in Hong Kong, according to Wind. Next, I'd like to invite our CFO, Arthur, to share insights on our financial performance.

Arthur Chen, CFO

Thank you, Leaf and Daniel. Now, please allow me to walk you through our financial performance in the third quarter. All the numbers are in Hong Kong dollars, unless otherwise noted. Total revenue was HKD2.7 billion, up 36% from HKD1.9 billion in the third quarter of 2022. Brokerage commission and handling charge income was HKD1 billion, an increase of 5% year-over-year and 6% quarter-over-quarter. Higher contributions from derivative trading lifted the blended commission rate from 8.8 basis points in the third quarter last year to 9.3 basis points this quarter. Interest income was HKD1.5 billion, an increase of 71% year-over-year and 7% quarter-over-quarter. The sequential increase was mainly driven by higher interest rates on clients' cash deposits, partially offset by lower cash balances. Other income was HKD137 million, up 28% year-over-year and 8% quarter-over-quarter. The increase was largely due to higher fund distribution income. Our total costs were HKD437 million, an increase of 101% from HKD218 million in the third quarter of 2022. Brokerage commission and handling charge expenses were HKD63 million, down 24% year-over-year and 14% quarter-over-quarter. The expenses didn't move in tandem with brokerage commission and handling charge income, mainly due to cost savings from our U.S. self-clearing business. Interest expenses were HKD289 million, up 546% year-over-year and 31% quarter-over-quarter. The year-over-year and the quarter-over-quarter increases were both driven by higher interest expenses associated with our securities lending business. Processing and servicing costs were HKD86 million, down 6% year-over-year and 13% quarter-over-quarter. The year-over-year decrease was mainly due to saving from cloud service fees as a result of system optimization, and the quarter-over-quarter decrease was mainly due to lower system usage fees. As a result, total gross profit was HKD2.2 billion, an increase of 28% from HKD1.7 billion in the third quarter of 2022. Gross margin was 84% as compared with 89% in the third quarter of 2022. Operating expenses were up 17% year-over-year and 5% quarter-over-quarter to HKD893 million. R&D expenses were HKD360 million, up 15% year-over-year and down marginally by 1% quarter-over-quarter. The year-over-year increase was mainly due to higher R&D headcount as we continue to upgrade our infrastructure, roll out new products and features, and customize products for international markets. Selling and marketing expenses were HKD212 million, down 10% year-over-year and up 21% quarter-over-quarter. The expenses declined year-over-year due to lower customer acquisition costs, and the quarter-over-quarter increase was primarily driven by accelerated paying client growth. General and administrative expenses were HKD322 million, up 52% year-over-year and 3% quarter-over-quarter. The rise was primarily due to an increase in headcount for general and administrative personnel to support our international markets. As a result, our net income increased by 45% year-over-year, and it declined by 3% quarter-over-quarter to HKD1.1 billion. Net income margin expanded to 41% from 39% in the same quarter last year, mainly due to strong revenue growth and lower selling and marketing expenses. That concludes our prepared remarks. We would now like to open the call to questions. Operator, please go ahead.

Operator, Operator

The first question comes from Leon Qi with Daiwa. Please proceed.

Leon Qi, Analyst

Hi. Thanks for taking my question. I appreciate management for addressing my inquiries. This is Leon from Daiwa. My first question is about our new markets, particularly in Japan. I understand we just launched there in late September. I'm curious about user behavior regarding our new clients in Japan. Are there any early signs concerning trading velocities, margin lending penetration, and the specific trading products that our Japanese clients are engaging with? Are there any significant differences in these metrics between customers in Japan and those in other markets? Additionally, I would like to know the customer acquisition cost for us in Japan, so any insights into the unit economics in that region would be appreciated. My second question pertains to wealth management. We recognize the rapid growth of our assets under management in this sector, and as management has pointed out, the money market fund plays a significant role in that growth. This is likely influenced by high U.S. interest rates. However, considering a cross interest rate cycle perspective, what proportion does management expect non-money market fund products to contribute to our overall wealth management assets under management, and what is our current take rate on the money market fund? Thank you very much.

Arthur Chen, CFO

Thank you, Leon. Let my colleague Daniel answer the first question first, and I will answer the second question. Thank you.

Daniel Yuan, Chief of Staff

Sure. So, unfortunately, we now only offer U.S. cash equities trading to our Japanese clients. So, we don't have margin, we don't have Japanese stock trading, so we only have data for client behavior on the U.S. stock trading. And so far, the turnover of the U.S. stock trading is not so different from what we've seen in other markets. That being said, we have a very aggressive and ambitious product roadmap for next year, and some of the products that I mentioned that we don't support now will be rolled out in the next couple of quarters. In terms of client acquisition cost, because we are coming from a small base of clients, whereas we have a lot of fixed costs for, like, setting up markets, setting up offices in Japan, and hiring marketing personnel. So, obviously, our CAC for this quarter and next quarter in Japan will be higher than our group average. But, over time, as we increase the number of clients in Japan, the CAC will gradually come down. So far, we have no reason to believe that the CAC in Japan will be higher than what we've seen in other markets. Just to give you some other colors and updates on our Japan business, we now have slightly over 400,000 users on our platform, and overall users have been very active. We observe that, on average, during the trading days, our DAU to user ratio is close to 20%, which is the highest among all of the markets we are currently in. User growth, along with paying client growth, will be our key priorities for next year. Thank you.

Arthur Chen, CFO

For the second question about wealth management, the key for us is to engage clients and focus on their long-term value. Therefore, we don't prioritize short-term monetizations. That said, the take rate for money market funds is similar to that of our other products, like equity and fixed income. We have developed a comprehensive range of products in our Dasheng Taipu, including equity and fixed income products in addition to money market funds. Recently, as Leaf mentioned, we launched free-floating rate note products in the last two quarters and have seen significant growth. We believe these offerings will help diversify our clients' asset allocations and assist them in navigating various interest cycles in the future.

Operator, Operator

Thank you. Next question comes from the line of Chiyao Huang with MS. Please go ahead.

Chiyao Huang, Analyst

The first question is about the decline in idle cash we observed recently. What might be causing this? Are some existing clients moving their cash to mutual funds or other investment products? Additionally, regarding new client AUM inflow, what is the approximate ratio of stocks to other investment products like mutual funds? The second question concerns our strategy in Japan, as we're noticing local brokers offering zero commissions. What is our competitive strategy in that market, and how are we thinking about future monetization? Would we consider expanding our financial offerings and capabilities in Japan to improve monetization in the long run? Thank you.

Arthur Chen, CFO

In response to your first question, the decline in idle cash was mainly due to our clients reallocating their cash towards more equitable stocks, particularly in U.S. stock assets at the end of the quarter. Additionally, some clients directed more funds into the wealth management process during the quarter-end. Regarding new client inflows, the distribution among cash, stocks, and wealth management is approximately 70% in stock positions, 10% in wealth management products, with the remainder consisting of idle cash. Thank you.

Daniel Yuan, Chief of Staff

Chiyao, I'll address your second question regarding our monetization strategy in Japan. We've noticed that a few leading brokers in Japan have moved to zero commissions for Japanese stock trading, and we anticipate that others will likely do the same. While it's challenging to generate profits from Japanese equities trading, U.S. stock trading remains quite lucrative. For instance, SP and Rakuten charge USD0.45 for trading U.S. stocks. We generally set our prices more competitively than those established players, yet we still expect to preserve a reasonable margin on U.S. stock trades. By the end of last year, there were 2.3 million U.S. stock investors in Japan. This number is relatively small compared to Japanese stock investors, but it has been increasing rapidly. At the end of 2019, there were approximately 1 million U.S. stock investors, meaning it has more than doubled in four years. In addition to revenues from U.S. stock trading commissions, we plan to monetize margin financing and foreign exchange fees. Japanese investors have shown a strong preference for trading on margin; on average, around 50% of their trades involve margin. This will be an important revenue driver for us. Regarding foreign exchange fees, we know that to offset zero commissions in Japanese stock trading, all brokers in Japan impose significant charges for FX. As the trading volume of U.S. stock trading on our platform increases, we expect foreign exchange revenues to contribute meaningfully. Thank you.

Chiyao Huang, Analyst

Thank you very much.

Operator, Operator

Thank you. Next question comes from the line of Cindy Wang with China Renaissance. Please go ahead.

Cindy Wang, Analyst

Thank you for taking my question. I have two questions. The first is about the Japan market. Can you provide an update on the progress of Japan's meeting plans? What is the conversion rate from registered users to paying clients? Have you noticed an increase in new paying clients month-over-month? My second question pertains to the subsidiary applying for a Digital Assets Trading Platform in Hong Kong. What does the progress look like? What preparations are being made for the Digital Assets Trading Platform? Will you be able to launch trading functions immediately after your license is approved? Thank you.

Arthur Chen, CFO

Thank you, Cindy. I will address your second question first, and my colleague Daniel will respond to your inquiry about Japan. We support the Web3 policies promoted by the Hong Kong Government, which aims to establish Hong Kong as a leading Web3 hub. Over the past several quarters, we have closely examined the policies and regulations set forth by the Hong Kong SFC. TensorTrade, a wholly-owned subsidiary of Futu Group, submitted its VATP license applications to the Hong Kong SFC last month. We anticipate that the entire application process may take at least six to nine months. If we are fortunate enough to receive approval in principle, we have not yet developed a detailed business plan afterward. We will continue to refine this over the next couple of quarters and, hopefully, we can provide some new updates in the upcoming Q2 or Q3. Thank you.

Daniel Yuan, Chief of Staff

I'm going to translate for myself. Currently, in Japan, the user to client conversion rate and the client to paying client conversion rate are both lower than we have seen in other international markets. We believe there are two main reasons for this. First, our account opening process still faces several challenges. The mid-to-back office operations in the Japanese brokerage industry involve many outsourced systems that offer a poor user experience. To expedite the account opening, we utilized some of these outsourced systems, which negatively affected our users’ experience and, consequently, the conversion rate from account opening to asset deposit. In the upcoming quarters, we aim to invest in our account opening process and gradually replace these outsourced systems with our proprietary system. The second reason for the low conversion rate is the limited availability of key trading products. Currently, we only provide U.S. cash equities trading to Japanese users. Early next year, we plan to introduce Japanese stock trading and LISA accounts. While we are confident that Futu’s U.S. stock trading capabilities greatly surpass those of our Japanese competitors, investing in Japanese stocks remains very popular in Japan. According to our user survey, the absence of Japanese equity trading is a significant factor deterring potential clients from opening accounts with us. Thank you.

Operator, Operator

Mr. Wang, are you finished with your question?

Cindy Wang, Analyst

Yes. Thank you.

Daniel Yuan, Chief of Staff

Yes, I'm done. Thank you.

Operator, Operator

Next question comes from Peter Zhang with JPMorgan. Please go ahead.

Peter Zhang, Analyst

Okay. Let me translate. My first question is a follow-up regarding the Japan product line. I would like to know if clients in Futu's Hong Kong or Singapore markets will be able to trade Japanese stocks in the future. Is this product in your plans? My second question concerns the blended commission fee rate. We observed a sequential decline in the blended commission fee rate in the third quarter. We would like to understand the reason for this and what the trend will look like moving forward. Thank you.

Arthur Chen, CFO

Regarding the two questions, the first is about our Japan stock trading offering to markets outside of Japan. The answer is yes, and it is already part of our product lines. We hope to launch Japan stock trading for our clients in Hong Kong and Singapore soon. We believe this offering will enhance client engagement in these markets and increase participation on our platform, ultimately benefiting our revenue. As for the fluctuation in the blended commission rate, as we have discussed in previous quarters, it is mainly due to client trading behaviors. Our U.S. stock trading commissions offer different options, and one of those is based on the number of shares rather than the trading volume percentage. When clients trade large blue chips or OTC stocks, this combination affects the blended commission base as well. In the third quarter, the fluctuation was primarily due to this. Looking ahead, we think that excluding these trading patterns, the blended commission rate can remain stable in the near future. Thank you.

Peter Zhang, Analyst

Trading commissions vary based on different structures, with one not tied to a percentage of trading volume but to the number of shares. When large blue-chip or OTC stocks are traded, this can affect the blended commission base. In the third quarter, this fluctuation was primarily due to those factors. Looking ahead, we believe the blended commission rate, excluding the impact of these trading patterns, should remain stable in the near future. Thank you.

Operator, Operator

Thank you. Next question comes from the line of Li Wan with BOCOM International. Please go ahead.

Li Wan, Analyst

Can you provide a breakdown of interest income and explain how the Fed's rate cut next year will affect it? Thank you.

Arthur Chen, CFO

In terms of interest incomes, year-to-date, the interest revenues from client idle cash are significantly higher than the interest income from margin lending and securities lending. Looking ahead, we don't expect the Fed's rate cuts to happen rapidly. When rate cuts do occur, they typically boost trading volumes across the capital markets for our clients. As a result, we believe that any drop in idle cash revenue due to the rate cut will be largely compensated by an increase in trading revenues. Thank you.

Operator, Operator

Ms. Wan, are you done with your question?

Li Wan, Analyst

Yes. Thank you.

Operator, Operator

Thank you. Next question comes from the line of Emma Xu with BofA Securities. Please go ahead.

Daniel Yuan, Chief of Staff

Well, it seems that Emma is not here tonight. So, if the operator, do you have any further questions on the line?

Operator, Operator

There are no more questions. So, I will now hand the call back over to Mr. Yuan for closing comments. Thank you.

Daniel Yuan, Chief of Staff

Sure. Yes. So 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.

Operator, Operator

Thank you. This concludes our conference for today. Thank you for participating. You may now disconnect.