LexinFintech Holdings Ltd. — FY2017 Form 20-F
Reporting period: Fiscal year ended December 31, 2017. This is an annual report, not a standalone fourth-quarter filing. Financial statements are prepared under U.S. GAAP; amounts below are in RMB unless stated otherwise.
Business context
Lexin operates Fenqile, an online consumer finance and e-commerce platform focused on educated young adults in China, and Juzi Licai, an online investment platform. It originates installment purchase and personal installment loans and matches them with individual investors and institutional funding partners. The company completed its Nasdaq IPO in December 2017.
Financial and operating performance
| Metric | FY2017 / Dec. 31, 2017 | Comparison |
|---|---|---|
| Total operating revenue | RMB5.582 billion (US$858 million) | Up 28.7% from RMB4.339 billion in 2016 |
| Financial services income | RMB3.015 billion | Up 92.9%; 54.0% of revenue, versus 36.0% in 2016 |
| Online direct sales and services income | RMB2.567 billion | Down 7.5% |
| Gross profit / gross margin | RMB1.320 billion / 23.6% | RMB602 million / 13.9% in 2016 |
| Operating expenses | RMB844 million | Up 42.9%; R&D rose 84.8% and G&A 133% |
| Credit-loss provision | RMB612 million | Up 159% from RMB237 million |
| Net income | RMB240 million (US$36.9 million) | Versus net loss of RMB118 million in 2016 |
| Net income attributable to ordinary shareholders | RMB26 million | After preferred-share accretion and RMB132 million income allocation to participating preferred shares |
| Operating cash flow | RMB1.662 billion | RMB380 million in 2016 |
| Investing cash flow | Negative RMB5.424 billion | Primarily loan originations, partly offset by principal collections |
| Financing cash flow | RMB4.412 billion | Included funding-debt proceeds and IPO proceeds |
| Cash and cash equivalents | RMB1.126 billion | RMB480 million at year-end 2016; increase primarily reflected IPO proceeds |
| Restricted cash | RMB609 million total | Includes current RMB562 million and non-current RMB47 million; not generally available for corporate liquidity |
| Total assets / total liabilities | RMB14.730 billion / RMB13.028 billion | Shareholders’ equity was RMB1.702 billion, versus a deficit of RMB612 million in 2016 |
| Funding debts | RMB10.692 billion carrying balance | RMB10.525 billion short-term and RMB167 million long-term; approximately RMB10.854 billion, including interest, due within one year |
Loan originations grew 115% to RMB47.7 billion. Outstanding principal on the platform reached RMB19.3 billion, comprising RMB12.0 billion on-balance-sheet and RMB7.3 billion off-balance-sheet loans. Active loan customers increased to 4.08 million from 3.01 million; repeat customers represented approximately 80%, up from 74%. Customer acquisition cost fell to RMB99 from RMB127. The reported 2017 M6+ charge-off rate was approximately 2% for each quarterly vintage from 2015 through 2017; loans charged off after 180 days during 2017 equaled 3.59% of average outstanding principal.
Material changes and management commentary
- Revenue growth was driven mainly by increased loan balances and financial services income. The mix shifted toward financial services; direct online sales declined as Lexin allocated more resources to its marketplace.
- Gross margin improved as financial services became a larger share of revenue. Management said the e-commerce channel is used primarily to attract and retain customers and convert them into borrowers, rather than to generate gross profit.
- Credit-loss provisions, funding costs and operating expenses all increased alongside the rapid expansion of lending and servicing. Effective APR on on-balance-sheet loans was 24.8%, compared with 25.0% in 2016.
- At year-end, the company reported net current liabilities of RMB123 million. Management stated that cash, anticipated operating cash flows and financing availability were expected to cover general needs for at least the next 12 months; it also noted continued dependence on funding partners and investors to finance customer loans.
- The RMB100 million convertible loan issued in 2016 was converted into preferred shares in October 2017; accrued interest was waived. Preferred shares converted into Class A ordinary shares upon the IPO. An associated RMB506 million liability to Series C-1 preferred shareholders remained reported at year-end and was included in obligations due within one year.
- There was no quantified financial guidance. Management cited continued growth and investment in technology and product development, but cautioned that future results may be affected by regulation, competition, credit performance, funding availability and economic conditions. Capital expenditure for 2018 was estimated at RMB36.7 million.
Risks, contingencies and unusual items
- Regulation and licensing: China’s online lending rules were evolving rapidly. Juzi Licai had not completed its required record-filing; Shenzhen regulators had not yet opened the filing process to intermediaries, and acceptance was uncertain. The company also disclosed uncertainty over renewal of its network microcredit license, which was due to expire in August 2018.
- Business-model changes: Campus lending, cash-loan practices, permitted fees, guarantees and loan-purpose requirements could require further changes or curtailment. In April 2018, after the fiscal year, Lexin said it ceased its quality assurance program and adopted a risk safeguard scheme managed by an independent guarantee company; accounting treatment was still being assessed.
- Credit and funding exposure: Loan quality, credit-model accuracy, collections and the ability to retain individual investors and institutional partners are key uncertainties. Most funding debt was short-term, and investor withdrawals could strain liquidity.
- Guarantee obligations: Lexin provides default-related support to certain institutional partners on off-balance-sheet loans. These guarantees are accounted for as fair-value derivatives; reported 2017 gain from fair-value changes was RMB47 million, a non-cash item that affected earnings.
- VIE and China risks: The company depends on contractual arrangements with variable interest entities to operate regulated businesses in China. Enforceability, foreign-investment restrictions, currency controls and restrictions on transfers of cash to the offshore holding company remain material risks.
- Reporting controls: Management concluded disclosure controls were not effective at December 31, 2017. The company and auditor identified a material weakness involving insufficient U.S. GAAP and SEC-reporting expertise and formal period-end controls. Management had begun remediation but could not assure it would be sufficient.
- Other: The filing reported no material legal proceedings. It disclosed underpayment of required employee benefits and under-withholding of employee income taxes, potentially exposing the company to back payments, late fees or penalties. The auditor’s China-based practice was not subject to PCAOB inspection at the time.
Important facts for investors to verify
- Whether Juzi Licai completed record-filing and obtained required licenses, and whether the microcredit license was renewed or its business replaced.
- Subsequent delinquency, charge-off and recovery performance, especially as personal installment loans and customer balances expanded.
- The liquidity and maturity profile of funding debts, restricted cash, preferred-shareholder obligations and deposits or guarantees supporting funding partners.
- Whether the post-April 2018 risk safeguard scheme is adequately funded, accepted by regulators and correctly reflected in subsequent financial statements.
- Progress in remediating the material weakness and whether later filings report effective disclosure and financial-reporting controls.
- The composition and cash impact of 2017 earnings, including preferred-share allocations, tax effects, fair-value derivative gains and other unusual items.