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Cango Inc. (NYSE:CANG)
Q2 2019 Earnings Call
September 3, 2019, 9:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning and good evening, everyone. Welcome to the Cango Inc. second quarter 2019 earnings conference call. At this time, all participants are in a listen-only mode. This call is also being broadcast live on the company's IR website. Joining us today are Mr. Jiayuan Lin, Chief Executive Officer, and Mr. Zhang Yongyi, Chief Financial Officer of the company. Following management's prepared remarks, we will conduct a Q&A session.

Before we begin, I refer you to the safe harbor statement in the company's earnings release, which also applies to the conference call today, as management will make forward-looking statements. Please note, this call is being recorded. I would now like to turn the conference over to Mr. Jiayuan Lin, CEO of Cango. Please go ahead, sir.

Jiayuan Lin -- Chief Executive Officer 

 [Through Translator] Hello, everyone. Welcome to Cango's second quarter 2019 earnings call today. During the first half of 2019, China's automotive industry continued to underwhelm into the decelerating macroeconomic environment, escalating China/US trade disputes, decreasing demand and industry uncertainties caused by new national emission standards, despite introduction of some regulatory changes to stimulate car sales by the government, the Chinese auto market is still operating at historic lows and has yet to recover.

Facing external pressure, we remain committed to our growth strategy and as a result, our businesses continued steady improvement over the past several months. During Q2, we continued to focus on strengthening our core competencies in auto loan facilitation services by refining our product offerings and expanding our channels.

We also accelerated the development of our after-market services while driving our auto insurance facilitation business to a [inaudible]. In addition, we further deepened our cooperation with our core strategic partners and our partnership with ICBC has yielded significant results. Moreover, we continue to establish new partnerships with founding partners and OEMs.

As a result of our efforts in these areas, our total revenue increased by 42.3% year on year to 336 million RMB in the second quarter. Our after-market services facilitation business, which mainly consists of insurance-related products contributed 35.9 million RMB to our total revenue. The significant contribution from our cooperation with ICBC was a vital driver of our strong financial performance in the second quarter.

Now, I will provide you with an update from the progress we achieved this quarter as well as the year's growth prospects of our core auto loan facilitation business, after-market services, and strategic partner initiatives.

First, as our primary growth driver, our auto loan facilitation business continued to deliver solid results. In Q2, the total amount of financing transactions facilitated reached 6.155 billion RMB with the outstanding balance standing at 36.394 billion RMB. On the funding side, we are currently in active negotiations for potential collaborations with multiple financial institutions, including Bank of China, China Construction Bank, China CITIC Bank, Shanghai Pudong Bank, [inaudible], and China Merchants Bank, etc.

We also continue to optimize and expand our dealership network while improving our service quality. As of the end of the second quarter, our dealership network includes more than 48,000 registered dealers across 353 cities in China. We continue to lead the market as the largest auto financing service platform in the country in terms of new car dealership coverage. Notably, we continue to penetrate lower-tier markets with almost 70% of dealerships that we cover allocated now in the tier 3 or lower tiers.

At the same time, we continue to implement our direct coverage model. By the second quarter, our sales team directly covered 91.6% of our dealers. The direct coverage model allows us to gain real insights into our dealers' specific needs and knowledge to provide dealers with solutions that back fit their demand to improve our channel.

As we expand our business and dealership network, we have prioritized risk management in our operation. Using machine learning algorithms, AI, and big data technologies, we have developed a proprietary risk management system. The system is capable of implementing a comprehensive multifaceted risk control mechanism to ensure that our auto loans could achieve solid performance. As of the end of the second quarter, the M1 and M3 overdue ratios were 0.72% and 0.3%, respectively.

We continued to expand our after-market services while driving our auto insurance facilitation business to the next level. In Q2, our after-market services business contributed 35.9 million RMB for 10.7% of our total revenue. The auto insurance facilitation business in particular, accident insurance, and anti-theft assurance services performed very well, completing 5,817 transactions in the quarter, up 88.2% sequentially.

Thirdly, we made further progress in our cooperation with our core strategic partners. Cango is the first auto financing service platform to complete interfacing with the bank's new system for car loans, that is with ICBC. As a result, we saw a significant increase in the loan volume made through our cooperation with ICBC's loan volume surpassing 580 million RMB in the second quarter.

In addition, through our partnerships with ICBC, we have also established collaborations with eight OEMs. These collaborations have enabled us to leverage our nationwide offline channels to launch OEMs subsidized auto financing and promotion services throughout China. We are now actively engaging with more OEMs for further collaboration.

For Didi, we facilitated over 250 car purchase transactions for licensed Didi drivers in the second quarter. We also provided Didi drivers with a complete suite of auto solutions, including car sourcing, auto financing, insurance, and licensing.

Moreover, we continued to push for strategic partnerships with OEMs, including leveraging Cango's extensive dealership network with strong penetration in lower-tier cities to expand the sales channels for OEMs, helping OEMs further diversify their product offerings in dealerships to address the needs of different consumer segments as well as retail and wholesale car sourcing.

During the second quarter, we signed collaboration agreements with BAIC Group, 51, [inaudible] and Chery Automobile. We are also currently in the process of negotiating partnerships with additional domestic and foreign OEMs.

It is also worth highlighting that we were recently certified by the Ministry of Science and Technology as a high and new technology enterprise. This is a powerful endorsement of our ongoing efforts in auto financing technology innovation. Going forward, we remain committed to advancing our auto financing services with data and technologies.

Although the auto industry is still facing challenges and macroeconomic uncertainties do exist, we are confident that as we continue to execute our growth strategies, efficiency while actively provide high-quality services to our partners and car buyers and effectively utilize our ample cash reserves, we will further consolidate our market-leading position going forward.

With that, I will now turn the call over to our CFO, Michael Zhang, to take you through our financial performance in the second quarter.

Yongyi Zhang -- Chief Financial Officer

Thanks, Jiayuan. Hello, everyone and welcome to our second quarter 2019 earnings call. Before I start to review our financials for the quarter, please know that unless otherwise stated, all numbers are in RMB terms and all comparators are on a year-over-year basis.

Although car sales in China continue to plunge due to uncertainty in the macroeconomic environment and escalation of the China/US trade war, we successful run through the tape, maintaining our strong growth momentum and delivering another quarter of solid financial results. Our total revenue in the second quarter 2019 was 336.3 million RMB, representing a year-over-year increase of 42.3%, outperforming the high end of the company's guidance by 6.8%.

Our after-market service facilitation business also continued to rev up, with our revenues growing to 35.9 million RMB. Cost of revenue in the second quarter was 125.8 million RMB. As a percentage of total revenue, cost of revenue in the second quarter increased to 37.4% from 34.4% in the prior year period. This increase was primarily driven by a higher amount of incentives paid to employees for each financing transaction.

Sales and marketing expansion in the second quarter increased to 44.5 million RMB from 37 million RMB in the prior year period, mainly due to increases in travel expenses as we further expanded our operations and share-based compensation expenses.

As a percentage of total revenue, sales and marketing expenses in the second quarter decreased to 13.2% from 15.7% in the prior year period. General and administrative expenses were 43.4 million RMB or 15.9% of total revenues. In the second quarter, compared with 31.4 million RMB or 13.3% of the revenue in the prior year period. This increase was mainly driven by higher share-based compensation expenses during the quarter.

Research and development expenses in the second quarter increased to 12.3 million RMB from 9.5 million RMB in the prior year period as we continued to expand our R&D efforts at investing in product innovation. As a result of our strong revenue growth and a successful optimization of cost structures, our income for operations in the second quarter increased by 17.3% to 84.3 million RMB from 71.8 million RMB in the prior year period.

Our net income in the second quarter was 94.6 million RMB, increasing 46.4% from 64.6 million RMB in the prior year period. Our non-GAAP adjusted net income, which excludes the impact of share-based compensation expenses increased by 66.7% to 116.9 million RMB in the second quarter. On a per share basis, our diluted net income for ADS was 0.6 RMB and our diluted non-GAAP adjusted income per ADS was 0.75 RMB in the second quarter of 2019.

Moving on to our balance sheet, as of June 30th, 2019, we had cash and cash equivalents of 1,609.6 million RMB compared with 2,178 million RMB as of March 31st, 2019. The change was due to that the company invested a certain amount of cash in term deposits over three months for better cash on cash return.

Looking forward to the third quarter of 2019, we expect our total revenue to be between 300 million RMB and 325 million RMB. Please note that this forecast reflects our preliminary review on the market and operational conditions, which are subject to change.

This concludes our prepared remarks. Operator, we are now ready to take questions.

Questions and Answers:

Operator

Thank you. We will now begin the question and answer session. To ask a question, you may press * then 1 on your touch tone telephone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press * then 2. In addition, for everyone's convenience, if you wish to ask a question, please ask your question first in Chinese and then immediately repeat your question in English. We will pause momentarily to assemble our roster.

The first question today comes from [inaudible] with Cango.

Unidentified Speaker -- Cango -- Analyst

So, my question is regarding our partnership with ICBC. I'm wondering how its related product and [inaudible] that we facilitate with ICBC. And [inaudible] also mentioned about other partnerships with some new banks. How is this proceeding? Can management give some guidance or outlook for the second half of the year regarding the car sales and our product development? Thank you.

Jiayuan Lin -- Chief Executive Officer 

[Through Translator] Thank you for your questions. I will answer your questions one-by-one. Regarding your first question, our partnership with ICBC -- we have been working with ICBC on the subsidized and non-subsidized front. Right now, the 1 billion RMB loans are all based on the non-subsidized loan products. For non-subsidized products, right now, the take rate is about 5%.

As I said, the ICBC loan volumes, the non-subsidized loan products, right now, the amount is over 1 billion RMB. Regarding the subsidized, we have signed agreements with eight OEMs and we have completed system configuration as well as product launch training with our OEM partners and we are now engaging with more OEMs.

Regarding with our engagement with the banks, with ICBC we are working very actively on non-subsidized products, but we are also working on subsidized products as well. The other banks in the market, they have witnessed the successful results of our partnerships, for example, like Bank of China and the Construction Bank of China, they have a strong interest.

These banks, they also boast very strong subsidized products, resources, especially already offering some subsidized products for OEMs in the China market. That's why we are now engaging with them and hope that with better incentives and better conditions for collaboration, we will be able to establish our partnerships with these other banks very soon.

Regarding your third question, our outlook for the second half, there are a lot of negative factors impacting the industry so far, like the slowdown in the macroeconomy and trade frictions between China and US, decreasing in consumption, a switch over from the national five emission centers, that's a reduction of the subsidy for new energy costs.

All these factors now are impacting massively on China's auto market in the second half of 2019. Although the government has launched some policies to stimulate car sales, we have not seen any turning point in the market yet. China's market has yet to recover. We are not very optimistic about China's auto market in the second half.

Facing these challenges in the second half will continue to impact expanding our dealership network, optimizing our service quality and efficiency, and advancing our technology through innovation as we continue to deepen our collaboration with more financial institutions and OEMs, we are confident we will sustain our approach despite the persisting industry challenges.

Operator

The next question comes from Joey Xu with Morgan Stanley. Please go ahead.

Joey Xu -- Morgan Stanley -- Analyst

Currently, the car dealer growth has already slowed down. Going forward, what's the management plan on the operating efficiency improvement front, such as increased dealer coverage efficiency of the salesperson or increase the number of credit applications per dealer? Thank you.

Jiayuan Lin -- Chief Executive Officer 

[Through Translator] To answer your question, yes, as you describe, we are facing a lot of challenges in the external environment. What we can do right now, of course, is to improve our internal capabilities. How do we do that? You probably know last month, we already launched the new sales management system, what we call the sales management system 3.0. With this new sales management system, we will be able to improve the productivity of our salespeople. That's the first point.

The second point, we are now working very closely with ICBC and other major banks in China to further penetrate our coverage of dealers across different regions. In other words, we are working on improving the density of our dealership coverage. We believe that with higher density, we will also be able to improve the operating efficiency. Thirdly, we are also focusing a lot of our efforts right now on after-market services. With that, I think we will also improve the productivity and operating efficiency very successfully. Thank you.

There is one other point I would like to add. That is right now, we are implementing a small-scale pilot program in the lower tier cities. That is we are providing supply chain financing solutions for the [inaudible] dealerships in the lower-tier cities because 70% of our dealers, they actually are located in the lower-tier cities. In these lower-tier cities, they have strong demand for car sourcing and also, for funding services. So, Cango has a strong competitive advantage in all these areas.

That's why we are trying to leverage these advantages to meet these dealers' demands for car sourcing and funding. Right now, this pilot program is still on a small scale, but we are confident that as the pilot program expands, we will be able to further expand our dealership network successfully and also, this program will help improve the dealers' stickiness with Cango. With that, we are confident that our business will further grow very strongly.

Operator

The next question comes from Michael Lee with Bank of America Merrill Lynch. Please go ahead.

Michael Lee -- Bank of America Merrill Lynch -- Managing Director

I'll repeat my question in English. This is Michael Lee from Bank of America Merrill Lynch. So, my question is in the first half, the overall auto market in China was quite weak but we still see quite strong growth of Cango's revenue in the first half, even except for part of the after-market service growth, the major business growth was quite strong. So, could management explain what Cango did right in the first half to outperform the car market in China? Thanks.

Jiayuan Lin -- Chief Executive Officer 

[Through Translator] Thank you, Michael, for your question. I think the reason for our strong growth in Q2 in the first half, actually, there are several contributors or drivers. The first one is from the product side -- Cango has [inaudible] to optimize our product portfolio. For example, for last year, we have increased our business with Bank of Shanghai.

Bank of Shanghai as a funding partner, in fact, offers a much lower cost of funding for Cango. So, that means we have a better or are in a more advantageous position in our partnership with Bank of Shanghai than with other funding partners. That's why we are more competitive than our industry peers in terms of cost funding in this regard.

Also, from the product side, there is another piece of information that our CEO touched upon earlier. That is in June, our non-subsidized products with ICBC increased strongly in volume. That's why on the product side, we have strong advantages. The second reason is that in the first half, the auto market in China underperformed, was not -- auto sales were not very high.

However, in this state, we are also experiencing both peaks and troughs. For example, in Q1, in January, we saw a small-sized rebound in the auto market. That is, the auto sales picked up for a brief period of time. I think the reason was mainly because of the lacking -- because some consumptions that should have taken place in 2018 now were postponed to January and Q1 for 2019. So, this lacking effect has led to this rebound in the car market. Cango has successfully taken advantage of this rebound.

In addition, we have earlier improved our dealership network management. That is, we are now focusing more on direct coverage. So, this is another reason that we can take advantage of this opportunity to achieve better market performance. In addition, in June of this year, we noticed another rebound in the market.

I think this rebound was triggered by a switch from national emission standard five to national emission standard six. Because of this switchover, a lot of OEMs started promotional programs for their national car products. That's why there was this brief period of strong sales in the market again. Again, Cango was able to catch this opportunity in improve our business.

The third reason is that since 2018, Cango has made a lot of efforts to better manage our channels. For example, we have changed our channel management model. We have also impacted a lot of to improve the dealerships with Cango. Despite the lower sales in the car market, we are able to improve our market share through our dealership network. Our single dealer or single store penetration rate has successfully improved, thereby improving our market share. All these reasons are drivers of our strong growth in the first half of this year. In addition, there also is contribution from our after-market service as well.

Michael Lee -- Bank of America Merrill Lynch -- Managing Director

[Through Translator] You described your partnership with the Bank of Shanghai and talked about lower cost of funding and it's a major contributor to your revenue growth in the first half because Cango's business model is acting as a facilitator. So, the bank provides the funding for the customers and the bank pays a take rate to Cango.

So, lower cost of funding doesn't mean that the take rate received by Cango from the banks will increase. In addition, we expect the inter-bank interest rate to go down in the second half. Actually, it has gone down in the past few periods. What is your outlook for the second half in terms of the cost funding? The cost of funding, will it continue to go down and will that lead to higher to take rate for Cango?

Jiayuan Lin -- Chief Executive Officer 

[Through Translator] The answer follows -- first of all, indeed, as you have described, the lower funding cost means that higher take rate for Cango. The second point I would like to make is that lower cost of funding is bringing another benefit. That is to the customers. The APR we offer to customers go down with the lower funding cost.

That improves the Cango competitors on the product side as well as on the channel side. So, higher take rate means higher revenue for Cango and lower cost of funding means we are more competitive on the channel side as well. That's why we have seen growth both on the price side and also, on the volume side for Cango.

The second point I'd like to make is that indeed, we expect the overall market cost of funding in the second half and regarding our partnership with ICBC and the Bank of Shanghai, yes, indeed, as the market cost of funding is going down, our cost of funding with these partners will go down as well.

Operator

The next question comes from Tian Hou with T.H. Capital. Please go ahead.

Tian Hou -- T.H. Capital -- Analyst

So, the recent trade war, China increased tariffs importing components from the US. How is that going to impact dealers and how is that going to impact you? That's the number one question. Number two, recently we see China's financial system [inaudible]. So, in your future development, how can you make sure you're not -- work together with some [inaudible] local regional bank. That's the second question. Third question, recently, we saw some higher delinquency rates from consumers borrowing and lending. I wonder, in your cooperation with the state bank, what's the term you will enter into with them for those delinquent loans? Thank you.

Jiayuan Lin -- Chief Executive Officer 

[Through Translator] Thank you for your questions. The first question about the impact of China-US trade frictions and the higher tariffs on imported auto parts from the US and the impact on that -- right now, we haven't seen the impact on that yet. While we do expect see impact, so far, we have not yet seen the real impact. The reason, I think, is mostly because most of our customers, they are buyers of domestically produced cars and they are located in the lower-tier cities.

I think that takes time for such an impact to transfer to such customer segments and to such market segments. So far, we have not seen substantial impact yet. Also, a slowdown in China's economy does have an impact on the market. For example, while Cango indeed has outperformed the market as a whole, however we have not seen the growth rate, especially in terms of sales as high as we expect it to be, despite the heavy investment we have made in improving our sales product and improving our channel.

So, the growth rate is not as high as we have expected it to be. In addition, to control risk, we have rejected a lot of applications from our customers. The rejection rate from Cango has increased. This also shows the impact of the economic slowdown of our business, on Cango, in order to better control risk. We have more customers than many of our peers. Regarding our partnership with the smaller banks, our partners are all major banks in China. We have no small bank partners.

Yongyi Zhang -- Chief Financial Officer

[Through Translator] I would like to add something to the answers. First of all, regarding our funding partners, first of all, as Mr. Lin described, we are working with the major banks so far. So, in terms of size, we only work with the big banks. In addition, we are diversifying our funding sources. That is, we are now working with the different types of different funding partners. Regarding funding, we are very safe. About your question on overdue rates, this also has something to do with our business model.

For our loan facilitation services, there are two types of loan facilitation services. The first one is Cango takes the credit risk and the second one is that Cango does not take the credit risk. We have started our collaboration with ICBC and Shanghai Bank, not for long. We are still at the beginning of our partnership. Cango decides to take on the guaranteed responsibilities. We take on the credit risk. In other words, if the loans are overdue, Cango has to buy back the loans.

Jiayuan Lin -- Chief Executive Officer 

[Through Translator] As I said, for some of these loan collaborations with the banks, Cango takes the buyback obligations. Cango takes the credit risk. But in turn, Cango gets a higher take rate from the banks for such products in order to compensate for the credit risk that we take on. But such a model, as I described, is just for the beginning of our partnerships.

Our strategy is that as we show, our banking partners, our strong performance, then we will be able to renegotiate with our founding partners on these terms, especially when we reveal our performance after a series of collaborations. Our plan is that in the future, then Cango will focus more on products on which we do not take any credit risk.

Operator

This concludes our question and answer session. I would now like to turn the conference back over to management for any closing remarks.

Jiayuan Lin -- Chief Executive Officer 

[Through Translator] If you have no more questions, then that's it for today. Thank you very much.

Yongyi Zhang -- Chief Financial Officer

Thank you, everyone.

Operator

This conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

Duration: 61 minutes

Call participants:

Jiayuan Lin -- Chief Executive Officer 

Yongyi Zhang -- Chief Financial Officer

Unidentified Speaker -- Cango -- Analyst

Joey Xu -- Morgan Stanley -- Analyst

Michael Lee -- Bank of America Merrill Lynch -- Managing Director

Tian Hou -- T.H. Capital -- Analyst

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