Earnings Call Transcript - FUTU Q3 2021

Operator, Operator

Hello, ladies and gentlemen, welcome to Futu Holdings Third 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.

Daniel Yuan, Chief of Staff and Head of IR

Thanks, Operator, and thank you for joining us today to discuss our third 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.

Leaf Li, Chairman and CEO

Thank you all for joining us today. In our third quarter, we added 166,000 new paying clients, bringing our total to 1.2 million. This marks our seventh consecutive quarter where over 50% of new paying clients were acquired organically. Our client retention rate for the quarter slightly decreased to 97% due to weakened market sentiment. We are continuing to implement our international strategy. In Singapore, we adjusted client incentives and budget allocations between brand and performance marketing to improve client acquisition efficiency. During the third quarter, we saw higher retention rates and consistent asset inflow across client cohorts. We are also expanding our product offerings in Singapore by introducing U.S. IPO subscriptions, structured warrants, and fund products. In Hong Kong, we remain a leading retail broker, with our users making up one-third of the adult population. We aim to further engage the younger, tech-savvy demographic and expand into groups currently underrepresented in our client base. Despite new competitors entering the crowded Hong Kong market, we are confident in maintaining our leadership position, as we believe that the key success factors for a broker include a trustworthy brand, an exceptional user experience, a comprehensive proprietary trading infrastructure, a strong capital base, and solid relationships with commercial banks, all of which take time to develop and represent our competitive strengths. By the end of the quarter, total client assets were HK$424 billion, showing a 111% year-over-year increase, although down 16% from the previous quarter. This decline was primarily due to a significant drop in some Chinese new economy stocks, though the mark-to-market effect was somewhat mitigated by strong net asset inflow. The average client asset balance fell to HK$363,000, affected by lower account balances in new markets. However, despite the tough market conditions, both total and average client assets in Singapore increased sequentially by 52% and 11%, respectively. For clients acquired two quarters ago, their average net asset inflow and account balance both tripled. Trading volume reached HK$1.4 trillion, a 33% increase year-over-year and a 3% increase quarter-over-quarter. Half of the total trading volume, HK$680 billion, came from U.S. stock trading, down 19% from the previous quarter due to decreased trading turnover in U.S. tech stocks. Meanwhile, we continue to grow our market share in Hong Kong's futures and options trading. Money Plus has formed new partnerships with notable asset managers, including Schroders and Carlyle, increasing our total asset management partners to 56. By the end of the third quarter, client assets in wealth management reached HK$17.7 billion, which is a 132% year-over-year increase. About 10% of our paying clients have wealth management positions. We are further enhancing our offerings for high-net-worth clients by onboarding additional alternative funds and collaborating with esteemed asset managers to provide curated online workshops. By the end of the quarter, we had 215 IPO and IR clients, as well as 325 ESOP solutions clients, which represents increases of 165% and 158% year-over-year. Companies such as HeyTea and Simple Love Yogurt utilized our ESOP services in the third quarter. Over 700 companies have established enterprise accounts with us, including more than 150 listed firms with market capitalizations exceeding HK$10 billion. In the third quarter, BYD Auto, JD Health, Pop Mart, and others began using our enterprise accounts to communicate with retail investors and share business updates. Next, I would like to invite our CFO, Arthur, to discuss our financial performance.

Arthur Chen, CFO

Thanks, Leaf and Daniel. 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. Our total revenue was HK$1.7 billion, up 83% year-over-year and 10% quarter-over-quarter. Brokerage commission and handling charge income was HK$933 million, an increase of 66% year-over-year and 17% quarter-over-quarter. The increase was driven by the 33% year-over-year growth in total trading volume and the higher blended commission rate of 6.9 basis points. Since most of our clients adopt the commission-per-share pricing model for U.S. stock trading, there's a decrease in the average share price of stock they trade, resulting in a higher blended commission rate. Higher contributions from derivatives trading also supported our commission rate expansion. Interest income was HK$632 million, an increase of 129% year-over-year, and up 4% quarter-over-quarter. The year-over-year and quarter-over-quarter increase was both driven by higher margin financing and the securities lending income, partially offset by lower IPO financing interest income. Other income was HK$166 million, up 56% year-over-year and down 2% quarter-over-quarter. The year-over-year increase was primarily due to increase in enterprises public relationship service charge income and the currency exchange service income. The quarter-over-quarter decrease was mainly due to the decrease in IPO subscription fees and underwriting fee income in a very active IPO market. Our total cost was HK$267 million, an increase of 47% from HK$182 million in the third quarter of 2020. Brokerage commission and handling charge expenses were HK$125 million, an increase of 24% year-over-year, and a decrease of 14% quarter-over-quarter. The expenses didn't grow in line with the brokerage commission and handling charge income due to our upgraded service package with our U.S. clearinghouse and the lower IPO subscription fees. Interest expense was HK$74 million, up 57% year-over-year and down 7% quarter-over-quarter. The year-over-year increase was due to higher margin financing interest expenses and higher expenses associated with our security borrowing and lending business, though partially offset by lower IPO financing interest. Interest expenses didn't increase in line with interest income as we increasingly shift our funding mix towards lower cost funding sources. Processing and servicing costs were HK$67 million, up 100% year-over-year and 25% quarter-over-quarter. The increase was primarily due to an increase in system usage fees and the crowded service fees to process a higher number of concurrent trades. As a result, our total gross profit was HK$1.64 billion, an increase of 92% from HK$764 million in the third quarter of 2020. Gross margin was 85% as compared to 81% in the third quarter of 2020. Our total operating expenses were HK$764 million, up 177% year-over-year and 18% quarter-over-quarter. We continue to invest in international markets, and we estimate over 30% of our operating costs were devoted to overseas markets. R&D expenses were HK$224 million, up 50% year-over-year and 29% quarter-over-quarter. We continue to add headcounts to support the new product offering, U.S. clearing capabilities, and the product customization for international markets; approximately 40% of our R&D personnel were dedicated to our international efforts. Selling and marketing expenses were HK$403 million, up 263% year-over-year and 7% quarter-over-quarter. The writing spending was driven by higher branding and marketing expenses in Singapore and in the U.S. in particular. In the third quarter, approximately 40% of our selling and marketing expenses were spent on overseas client acquisition. G&A expenses were HK$137 million, an increase of 122% year-over-year and 42% quarter-over-quarter. The increase was primarily due to an increase in headcount for G&A personnel. As a result, our non-GAAP adjusted net income increased by 58% year-over-year and 17% quarter-over-quarter to HK$646 million, with non-GAAP net margin for the quarter being 37%. That concludes our prepared remarks. We would now like to open the call to questions. Operator, please go ahead. Thank you.

Operator, Operator

Thank you. Our first question is from Bella Zhang of TH Capital. Please go ahead.

Bella Zhang, Analyst

Hi, management. Thanks for taking my question. I have two. The first is about the regulatory impacts, specifically regarding the new draft from the Cyberspace Administration of China that requires a cybersecurity assessment for leasing in Hong Kong, especially for tech companies with data on over one million users. Do you foresee any negative effects on our IPO pipeline due to the new regulations from CAC? Should we anticipate a significant slowdown in the IPO pace in the fourth quarter and next year? The second question pertains to customer acquisition. There are concerns about the legality of offshore trading by online brokers. Could management provide insights on how government regulations might affect customer acquisition in Mainland China, especially considering potential hesitance from people to open new accounts? Additionally, will this influence your customer acquisition strategy?

Arthur Chen, CFO

Thank you. I will take the second question first. I will leave the first question to my colleague, Leaf. In terms of the China regulations, I think we are not in the best position to prejudge what the regulator will do. I think, so far, the impacts on our client positions in the Greater China areas are manageable. I can share a little more context which I think may be helpful for analysts and also the investors to gauge how the negative impacts on the recent headline news have implications for our client positions across the board. Definitely, we see certain asset outflows among clients in the Greater China areas due to concerns over media reports. Overall speaking, we think the impacts are very short-term and manageable. From mid-October to mid-November, the net asset outflows accounted for less than 2% of our total client assets. And the situation started to normalize from last week. In my humble opinion, I think the worst is already behind us. Of course, the market volatility, alongside the seasonal effect in Q4, together with this headline news, definitely enhance the attrition rate for the existing paying clients, and also creates some challenges for new client acquisition across the board in the near term. But we think that, overall speaking, the situation is still within our control. Thank you.

Leaf Li, Chairman and CEO

Yes, we are continuing our usual operations at Futu, and our business model is well-established. This type of business has existed for years before we started. Our size is relatively small compared to the entire industry. Our approach to serving clients is similar to many other international brokers and banks in Hong Kong that assist Chinese entities in accessing overseas trading. We operate under the same regulations as they do. Unlike our peers, we invest more in technology and innovation and prioritize user experience. We adhere to regulations rigorously and maintain high operational compliance standards. We maintain open communication with regulators and welcome guidance from them, anticipating and committing to comply with any new regulations promptly. As a public company, we will keep our stakeholders updated on any new information that arises. Regarding the IPO pipeline, we believe it is more influenced by the overall market conditions rather than cybersecurity investigations. The IPO landscape in Hong Kong over the next few quarters will largely depend on market trends. Historically, we derive a significant portion of our revenue from IPO-related activities such as subscription fees and margin financing, so we do not anticipate a substantial impact on our operations. We have numerous opportunities for growth, and as mentioned earlier, there remains a large, underserved population in Hong Kong that we can engage. Additionally, markets we have entered, like Singapore and the U.S., present considerable growth potential. Thank you.

Operator, Operator

Thank you. Our next question is from the line of Katherine Liu of Morgan Stanley. Please go ahead.

Katherine Liu, Analyst

I will translate for myself. Thank you for giving me the opportunity to ask a question. I have two questions. First, could management help us analyze the overseas market growth opportunities for Futu? Secondly, can the company provide guidance on operational data trends for the fourth quarter so far, such as client assets and velocity? Thank you.

Arthur Chen, CFO

Okay, sure. Katherine, let me just supplement the answer I mentioned before for your second question. Still, I will leave the first question to Leaf. I think in terms of client activities, we see investor sentiment warming up in the fourth quarter. Of course, in the fourth quarter, we face some long holidays, such as national holidays and also for Christmas. If we do take out the holiday effect in Q4, we expect the overall trading volume may be similar to Q3 based on the current run rate. In terms of client assets, as I mentioned before, we definitely got some negative asset outflows because of the headline news recently. But the situation started to normalize since last week, and in particular, we see very encouraging signals in our overseas markets, such as Singapore. In our opening remarks, Leaf mentioned that our average client assets in Singapore already jumped 11% quarter-over-quarter. I do believe on top of that, we will continue to see, on a total and also on an absolute basis in Singapore markets, we will see another at least 15% increase quarter-over-quarter on top of the growth that we achieved in Q3. And also in terms of our wealth management products, so far our assets in the wealth management segment have demonstrated strong resilience and we do expect more product offerings to be launched in Q4, which may further drive our AUM to continue to increase. Thank you.

Leaf Li, Chairman and CEO

In Q3, we had around 2.2 million users in Hong Kong, representing roughly 32% of the population over 18 in the region, which means that about one in three adults in Hong Kong use our service. Our penetration rate for users aged 20 to 29 in Hong Kong is about 20%, indicating that one in five people in this age group utilizes our product. We have a strong presence among young, tech-savvy users in Hong Kong, while we are also working to reach less represented groups such as middle-aged individuals and women. In Singapore, the adult population is approximately 4.9 million, and if about 30% of them have brokerage accounts, there are roughly 1.5 million retail investors, which presents significant potential for growth. As part of our international strategy, we plan to use Singapore as our Southeast Asian headquarters and expand into other countries in the region. Like Singapore, other Southeast Asian countries have opportunities for improvement in brokerage services and user experience. We estimate that there are about 33 million people in Southeast Asia, with 22 million being internet users. Based on the IP addresses of our current users, we believe Futu has already established strong brand recognition in many Southeast Asian countries. Additionally, we see growth potential in the U.S. market. We believe that NiuNiu effectively combines user-friendly mobile design with advanced product features, occupying a gap in the market between existing brokers. Our NiuNiu user base in the U.S. saw notable growth in Q3 as a result of robust initiatives and expanded client acquisition channels. Moving forward, we will adapt our client acquisition strategy according to market conditions to better target our desired client groups. Thank you.

Operator, Operator

Thank you. Our next question is from the line of Zoey Zong of Jefferies. Please go ahead.

Zoey Zong, Analyst

Thank you, management, for taking my question. I have two questions. First, I noticed that the company added 166,000 paying clients in Q3. Could you provide some details about the user distribution, specifically how many are from Hong Kong, Singapore, and the U.S.? Additionally, could you share the mix for the 1.2 million Swiss opening clients? My second question is about customer acquisition cost. The total customer acquisition cost was around HK$2,400 in Q3. How should we anticipate that figure for next year? Thank you.

Arthur Chen, CFO

Sure. I will address both of your questions. First, regarding the new clients acquired in Q3, approximately 60% come from the Greater China region. The remaining 40% includes roughly 28% from Singapore and around 11% from the U.S. For your second question about the market and expansion, we focus internally on the ARPU versus CAC ratio. The CAC numbers increased quarter-over-quarter, primarily due to market conditions that temporarily raised our attrition rate. Consequently, the average CAC went up slightly from the previous quarter. It is challenging to provide precise guidance for the CAC, as it will be significantly influenced by market conditions. However, we believe that user engagement remains our top priority since the cost for paying users to switch to competitors or other channels is quite high. Hence, we will prioritize growth while closely monitoring our unit economics to ensure they remain justifiable. For example, in Singapore, our payback period for paying clients was about 2.5 years earlier this year. After just one quarter, our average client assets have increased by 11%, and we anticipate another 15% increase in the fourth quarter. Looking ahead, we expect our unit economics to become more sound as we build trust with existing users who will deposit more funds, and we will enhance our offerings to improve our take rate. Thank you.

Operator, Operator

Thank you. The next question is from Charles Zoe of Credit Suisse. Please proceed.

Unidentified Analyst, Analyst

Okay, I will translate by myself. The first question I want to clarify is about the 2% outflow you just mentioned. What do you mean by that? You referenced Greater China—what period are you talking about? Could you provide a bit more detail on that? The second question relates to the onboarding process, due diligence, and risk management that you equate with banks. Are you referring to traditional commercial banks or private banks for a securities brokerage account? I also have two more questions. First, we understand that Futu has not implemented a zero-commission policy like many competitors. However, we've seen some promotions offering zero-commission trading through promotion codes, account openings, or coupon redemptions after the fact. What are your thoughts on this in relation to monetizing current AUM in Hong Kong and Singapore going forward? Lastly, regarding the share buyback, could you provide more details, such as the price at which you are buying back shares and how many shares you’ve already repurchased? Thank you.

Arthur Chen, CFO

Sure, Charles. You asked four questions. Let me address the first and fourth questions first and leave the second and third to Leaf. Regarding the client asset outflows, as I mentioned before, I would like to share some recent figures and implications from the latest headline news. It is quite challenging to pinpoint specific reasons for our client asset outflows, whether it's due to the news or other factors. However, looking back over the past month, we have experienced some net asset outflow, which is approximately 1% to 2% of our total asset balance at the end of the third quarter. Concerning the share buyback, this is a 13-month program, and due to SEC regulations, we cannot conduct any buybacks during the reporting blackout period. Therefore, we have not initiated any share buybacks yet. Thank you.

Leaf Li, Chairman and CEO

Sure, yes. As we mentioned earlier, we follow the same regulations and laws regarding our account opening procedures, KYC, and AML. We believe our practices align with those of other brokers and banks in Hong Kong, and we do not perceive any significant differences. The competitive landscape in the Hong Kong market has not changed much. In fact, the price wars among our competitors have been ongoing for several years. As noted in our opening remarks, we believe that the key success factors for a broker include a reliable brand, an excellent user experience, comprehensive proprietary trading infrastructure, a robust capital base, and strong relationships with commercial banks. These factors take time to develop, and Futu has established strong advantages in these areas. Furthermore, we understand that the main trading costs for Hong Kong stocks are from stamp duty, which is currently set at 3 basis points. We charge a commission of 3 basis points, which is relatively low compared to the stamp duty costs. Therefore, we do not feel significantly impacted by the price wars and have no plans to adjust our pricing. If pricing is the only strategy available to our competitors in the market, they may experience significant pressure if they do not achieve financial or operational results in the short term.

Operator, Operator

Thank you. We have now reached the end of our question-and-answer session. And I'd like to hand the conference back to Mr. Yuan for closing remarks. Please continue.

Daniel Yuan, Chief of Staff and Head of IR

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 other Investor Relations representative. Thank you, and goodbye.

Operator, Operator

Thank you. That concludes our conference for today and thank you for participating. You may now all disconnect.