Business Context and Reporting Period
The supplied filing is China Rapid Finance Limited’s annual report on Form 20-F for the fiscal year ended December 31, 2017, not an SOS Ltd filing or a quarterly filing. The company operated a China-focused consumer lending marketplace connecting borrowers with investors through predictive selection, credit scoring and automated decisioning technology. It also conducted a small micro-credit lending business.
The company completed its NYSE IPO in April 2017 under the ticker XRF, issuing 11.5 million ADSs and receiving approximately $63.0 million in net proceeds. Each ADS represented one Class A ordinary share. Financial statements were prepared under U.S. GAAP and reported in U.S. dollars, while operations and substantially all revenue were denominated in RMB.
Financial Performance and Key Metrics
| US$ in thousands, except per-share data | 2016 | 2017 | Change |
|---|---|---|---|
| Gross billings on transaction and service fees | 67,901 | 137,182 | +102.0% |
| Transaction and service fee revenue, net of incentives | 55,891 | 91,621 | +64.0% |
| Total revenue | 56,983 | 92,777 | +62.8% |
| Net revenue | 55,861 | 87,711 | +57.1% |
| Total operating expenses | 89,215 | 124,755 | +39.8% |
| Loss before income tax | (33,363) | (36,536) | Loss increased |
| Net loss | (33,366) | (36,649) | Loss increased 9.8% |
| Net loss attributable to ordinary shareholders | (40,378) | (121,551) | Includes $82,034 deemed IPO dividend in 2017 |
| Basic and diluted loss per share | $(2.46) | $(2.48) | Higher loss per share |
Net revenue rose substantially as consumption-loan billings increased to $87.4 million from $9.8 million. However, customer acquisition incentives increased to $38.1 million from $9.0 million, substantially reducing the conversion of gross billings into reported revenue. A separate $4.6 million discretionary payment to certain investors was recorded as a reduction of revenue.
- Consumption-loan volume increased to $2.85 billion from $611.5 million, and consumption-loan billings increased to $87.4 million from $9.8 million.
- Lifestyle-loan volume declined to $413.2 million from approximately $450.5 million, while lifestyle-loan billings declined to $49.8 million from $58.1 million.
- Total loans facilitated increased to 22.365 million from 6.006 million, and borrowers increased to 4.284 million from 1.420 million.
- Repeat borrower rate increased to 76% from 67%.
- Sales and marketing expense increased 51.4% to $45.3 million; general and administrative expense increased 47.3% to $54.1 million; product development expense increased 34.9% to $11.6 million.
- Research and development spending was $8.4 million, compared with $3.4 million in 2016.
Margins, Cash Flow and Liquidity
| Metric | 2016 | 2017 |
|---|---|---|
| Net revenue margin over total revenue | 98.0% | 94.5% |
| Net loss margin over net revenue | (59.7%) | (41.8%) |
| Operating loss | Not separately stated; implied from reported items | Approximately $(37.0) million |
| Net cash used in operating activities | $(26.7) million | $(5.7) million |
| Net cash used in investing activities | $(3.1) million | $(2.2) million |
| Net cash provided by financing activities | $24.0 million | $84.7 million |
| Cash and cash equivalents at year-end | $19.0 million | $94.9 million |
| Restricted cash at year-end | $12.7 million | $14.7 million |
The company remained loss-making and had negative operating cash flow, although operating cash use improved materially in 2017. The year-end cash increase was primarily financing-driven, including approximately $63.0 million of IPO proceeds and preferred-share financing. Management stated that existing cash, projected operating cash flows and other current assets were expected to cover obligations for at least the following 12 months.
Total assets increased to $137.5 million from $58.5 million. Total liabilities increased to $78.5 million from $44.5 million. Mezzanine equity declined from $116.2 million to zero following conversion of preferred shares in the IPO, while shareholders’ equity improved from a deficit of $102.2 million to positive equity of $59.0 million. The filing does not present a conventional debt balance as a primary year-end metric; prior convertible notes and preferred shares were substantially converted or otherwise settled in connection with financing and the IPO.
Material Changes Versus the Prior Comparable Period
- The business shifted decisively toward short-term consumption loans. Consumption loans represented approximately 87% of loan volume by dollars in 2017, compared with 58% in 2016.
- Loan activity scaled rapidly, but the company continued to report annual net losses. The 2017 loss attributable to ordinary shareholders was disproportionately affected by the non-cash $82.0 million deemed dividend arising from the Series C preferred-share conversion at the IPO.
- Customer acquisition incentives increased more than fourfold to $38.1 million. The filing states that the average time to recover consumption-loan acquisition costs shortened from 4.1 quarters to 2.1 quarters, but this remains dependent on repeat borrowing and future fee generation.
- Overall default rates increased to 20.1% in 2017 from 14.9% in 2016 and 11.8% in 2015. The reported annualized default rate for consumption loans was 2% in both 2016 and 2017.
- The company changed its depository-bank arrangement, transferring fund-depository services from Hengfeng Bank to Bank of Shanghai in December 2017.
- In response to regulatory requirements, the company ceased operating its Safeguard Program in February 2018. At December 31, 2017, restricted cash was $14.7 million and the Safeguard Program payable was $18.0 million.
- Management disclosed three material weaknesses in internal control over financial reporting: insufficient U.S. GAAP and SEC-reporting expertise, inadequate documented closing procedures, and insufficient documentation and evaluation of significant non-routine payments. Disclosure controls and procedures were deemed ineffective as of December 31, 2017.
Outlook, Commentary, Risks and Unusual Items
Management’s strategy was to acquire borrowers with smaller initial loans and increase loan size and term for borrowers demonstrating positive repayment behavior. Management expected repeat borrowing and larger loans to increase lifetime customer value and offset acquisition incentives. No formal financial guidance or quantified 2018 revenue or earnings outlook was provided.
- Regulatory risk: The PRC marketplace-lending framework was rapidly evolving. Filing requirements, loan-balance limits, interest and fee limits, fund-depository rules, information disclosure, cash-loan restrictions and restrictions on credit-enhancement services could require further changes to the business model.
- Safeguard Program discontinuation: Removing this investor-protection feature could affect investor participation, borrower and lender behavior, default recoveries and future loan volume.
- Credit and funding risk: Investors bear the credit losses on facilitated loans. Higher defaults or insufficient investor capital could reduce investor returns and impair loan originations.
- Revenue-quality risk: Customer acquisition incentives and discretionary investor payments materially reduce reported revenue. Consumption-loan fees are recognized largely as borrowers repay, creating timing and collectability risk.
- Liquidity and profitability risk: The company had recurring operating losses and negative operating cash flow. Liquidity was strengthened by IPO proceeds, but future funding needs could require additional equity or debt financing.
- China operating risk: Foreign-exchange controls, restrictions on upstreaming cash, PRC tax uncertainty, telecommunications licensing, data-security rules, nominee ownership arrangements and evolving enforcement could affect operations or cash transfers.
- Currency risk: Revenue and expenses were primarily in RMB, while reporting was in U.S. dollars. The company had not entered into hedging transactions.
- Unusual items: The $82.0 million deemed IPO dividend, $4.6 million discretionary investor payment, $38.1 million of customer acquisition incentives and the cessation of the Safeguard Program are central to interpreting 2017 results.
- Other commitments: Non-cancellable operating lease obligations totaled $11.7 million, including $4.6 million due in 2018. No material legal or administrative proceedings were disclosed.
Most Important Facts to Verify
- Verify the issuer and period: the supplied filing identifies China Rapid Finance Limited, fiscal 2017, rather than SOS Ltd or a 2017 fourth-quarter filing.
- Reconcile gross billings of $137.2 million to reported net revenue of $87.7 million, including the $38.1 million customer acquisition incentives, $4.6 million discretionary payment and business taxes.
- Assess whether the rapid growth in consumption-loan volume and the 76% repeat borrower rate continued after the 2017 regulatory changes.
- Verify post-February 2018 investor funding, default rates, recoveries and the effect of eliminating the Safeguard Program.
- Review the company’s regulatory filing and remediation status, including compliance with Circular 141, Circular 57, loan-balance limits and telecommunications licensing requirements.
- Track remediation of the three material weaknesses and determine whether subsequent filings report effective internal controls.
- Evaluate liquidity excluding restricted cash and customer funds, and determine how long unrestricted cash can support continuing operating losses and negative operating cash flow.
- Confirm the accounting and cash-flow effects of the company’s adoption of the new revenue-recognition standard, for which management estimated a $5.0 million impact on consumption-loan accounting.