FlexShopper, Inc.

Greetings, ladies and gentlemen, and welcome to Flex Shopper LLC 2022 Second Quarter Financial Results Conference Call. At this time, all participants are in listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the call, please press star then zero on your telephone keypad. As a reminder, this conference is being recorded. I would now turn the conference over to your host, Mr. Carlos Sanchez, Investor Relations.

Thank you, and good morning. Welcome to Flex Shopper's second quarter 2022 earnings result conference call. With me today are Rich House, Chief Executive Officer, Russ Heiser, Chief Financial Officer, and John Davis, Chief Operating Officer. We issued our earnings release last night and corresponding investor presentation this morning, and we will be referencing these during the call. Both can be found in our investor relations section of our website. We will be available for Q&A following today's prepared remarks. Before we begin, I would like to remind everyone that this call will contain forward-looking statements regarding future events and our financial performance, including statements regarding our market opportunity, the impact of our growth initiatives, and our future financial performance. These should be considered in conjunction with cautionary statements containing our earnings release and the company's most recent periodic SEC reports, including our quarterly report form 10Q for the second quarter ended June 30th. These statements reflect management's current beliefs, assumptions, and expectations and are subject to a number of factors that may cause actual results to differ materially from those statements. Except as required by law, we undertake no obligation to publicly update or revise any of these statements, whether as a result of any new information, future events, or otherwise. During today's discussion of our financial performance, we will provide certain financial information that constitutes non-GAAP financial measures under SEC rules. These include measures such as adjusted EBITDA and net income, adjusted net income. These non-GAAP financial measures should not be considered replacements and should be read together with our GAAP results, reconciliation to GAAP measurements, and certain additional information are also included in today's earnings release, which is available on our investor relations section of our website. This call is being recorded and a webcast will be available for replay on the investor relations section of our website. I will now turn the call over to Rich.

Thanks, Carlos. Good morning, everyone, and thank you for joining us for the Flex Shopper second quarter 2022 earnings call. This morning, I'll be joined by the CFO, Russ Heiser, and the Chief Operating Officer, John Davis. In today's call, we're going to stick with the format we used last quarter. I will provide an overview of our general results and strategies. Russ will cover the financial results in more detail, and John will provide some specific insights regarding how we are progressing on the execution of our strategies in both our leasing and lending endeavors. I will end with the prepared remarks with a brief summary of our future direction, and we will have time for any questions you may have prior to ending the call. We are pleased to report second quarter EBITDA of $6.4 million and net income of $14.4 million. Russ will walk you through a breakdown of these results in more detail shortly. I would like to spend some time focusing on how FlexShopper is dealing with the current macroeconomic environment and how we continue to provide profitable growth in this environment. I'm sure everyone on this call is aware of the US economy. has moved into a slower growth phase over the last nine months. And unlike previous slower growth phases in the past 40 years, this slower growth has been accompanied by significant inflationary pressures. The combination of slower growth, inflationary pressure, and a lack of continued government stimulus seems to have taken a toll on the non-prime consumer. This is an unusual time, in that there is not an employment problem, but the amount of money our consumers bring home from their employment is probably increasingly being spent on necessary expenditures, reducing the amount of money available to pay bills that are not required for everyday living. It is quite possible some of these consumers made purchases using leases or loans when they were benefiting from government stimulus programs and did not anticipate the future inflationary environment. It is probably impossible to unwind exactly what has happened regarding the non-prime segment of the consumer population over the past several quarters. However, it is obvious there has been an impact on their payment behavior. This has resulted in both Flex Shopper and our publicly traded competitors announcing increases in bad debt allowances over the last two quarters. Last quarter, we told you we had tightened our underwriting standards in order to deal with a declining economic environment. In the second quarter, we continued to tighten further to ensure we were exercising the appropriate amount of caution in an uncertain economic environment. The important part of the story we believe separates FlexShopper from others is we can continue growing even while we exercise the appropriate discipline regarding credit risk. I will now turn the call over to Russ for a review of the financial highlights and an overview of a new retail strategic partnership.

Thanks, Rich. Our second quarter financial results reflect the challenging operating environment as our customers manage these inflationary conditions. We are navigating the situation by adjusting the items that are within our control. This has included significant changes to our underwriting approval rates, new technologies around portfolio servicing, and focusing on SG&A to align with the current environment. Last quarter, we announced we had completed the testing phase of our lending business, and we're moving into initial rollout phase. Lending grew substantially in the second quarter of this year, and we are confident it will continue to add to our growth and profitability moving forward. Lending is a natural complement to our existing leasing program, which is confined to only durable goods. capability of adding a lending product offering to our current lease-to-own offering significantly increases the size of the addressable market for FlexShopper, providing additional avenues for growth. Finally, the second quarter of this year does not resemble the economic conditions of the second quarter of the prior year. In addition, our company has evolved significantly over the past year with the additional financing product and new retail channels. Therefore, I'm going to not only cover the change versus the same quarter last year, but also the change versus the prior quarter. Total revenue for the second quarter of 2022 was $36.5 million, which was up 19.1% year over year and up 26.2% versus the prior period. Lease revenues were $30.5 million, which are down 0.6% year over year, but up 9.7% versus the prior quarter. Loan revenues were $6.1 million, up from only $26,000 a year ago and up over 400% from the prior quarter. Gross profit was up 6.5 million or up 58.2% versus the same quarter last year and up 87.2% over the previous quarter. This was primarily due to an increase in net loan revenues and a focus on monetization of delinquent accounts. Operating expenses were up 2.6 million year over year. The total operating expense growth is largely driven by three factors. First, there was a $1.9 million increase in direct marketing expense to drive the growth and total fundings of both leases and loans. Next, there were about 200K of one-time costs related to expanding the underwriting and marketing teams and feel those new additions are already contributing. The final $500,000 is related to the new strategic businesses and includes employees and variable costs for the loan servicing, as well as growing our wholesale initiative. All of these expenses were in our budget and are part of our strategic growth plan. which Rich will discuss in more detail. Adjusted to EBITDA was $6.4 million, an increase of $4.25 million year over year, up from $2.1 million in the second quarter of 2021 and up $6.5 million versus the prior quarter. Our net income for the second quarter of 2022 was $14.4 million compared to net income of $942,000 in the second quarter of 2021. The release of the deferred tax asset valuation allowance resulted in a tax benefit of approximately $12.5 million in the second quarter of 2022. Excluding the tax benefit, net income during the second quarter was $1.9 million, or double the same quarter last year and up $4.2 million versus the first quarter. The last point I want to touch on is our retail partnerships and our new technology partners. The bulk of our legacy brick and mortar retailer partners have been 500 plus door regional and national retailers. Our technology initiatives were developed to onboard these types of retailers quickly and enable rapid rollout without immediate integration into the point of sale. Unfortunately, this segment of the market is extremely competitive and has a very long sales cycle. However, we had a significant backlog of smaller retailers that we could not onboard as quickly or efficiently as we wanted due to our legacy technology. Since the beginning of the year, we've been looking for a path to allow us to enter the smaller retailer market and recently entered into an exclusive relationship with a technology partner that is enabling us to onboard and service a single store retailer as well as our 800 store partners. As such, we expect our door count to increase by 1,600 doors before the end of this year. As a reminder, we started this year with 1,250 doors and expect to end the year around 3,000 active doors. Our addressable market of brick and mortar retailers has increased significantly and combined with our suite of financing products will boost our retail presence while also diversifying into more small and medium-sized retailers. Of course, That hasn't changed our strategy around adding additional national retailers or expanding our current relationships with the larger retailers. In fact, one of our larger lease-to-own retailers also has storefronts that were not suited for us historically because of their focus on non-durable goods. That retailer is now increasing our footprint with them via the loan alternative. We expect it to start piloting this fall, and based on the timing of the full rollout, we will be in an additional 500-plus stores by the end of the first quarter of 2023. Our sales pipeline continues to stay robust and is a testament to our approach of offering a variety of products accessible both online and in the stores. I'll now turn it over to John to discuss our operations in more detail.

Thanks, Russ. As Rich and Russ have both mentioned in their remarks, we are operating in a challenging environment for our customers with inflation levels not seen in decades. Our customers have lower spending power in their wallets, and their available cash is being prioritized for housing, food, and other necessities, and essential items such as car payments, mobile phone service, and other key obligations. As mentioned in our last earnings call, we tightened our underwriting standards in Q1 of this year in response to these conditions. While these actions have resulted in better year-over-year early default rates, we have continued to see stress in our consumer payment performance in Q2. As a result, we have continued to tighten our underwriting standards within our lease business over the past quarter. This has resulted in a further reduction in approval rates for new customer applicants. To put this into perspective, we have reduced our approval rate by 38% in Q2 this year compared to what we were approving in Q2 of last year, which is a significant move lower. Despite this tightening, I am pleased to see our year-over-year lease dollar origination volume improve from last quarter's 18% down to flat year-over-year this quarter. Additionally, we are up over 20% in lease dollar volume quarter-over-quarter overall despite the credit tightening. Our partnership lease business is up over 55% year-over-year and 22% quarter-over-quarter driven by an increase in new door fronts, which we expect to continue to see through the rest of this year. Regarding our marketplace lease business, Lease volume is down year over year with the decline in approval rates from our credit tightening. However, lease dollar volume from the marketplace is up 21% sequentially from last quarter, which is being fueled by higher new customer volume, even despite our credit tightening. This sequential growth is happening for a few reasons. Our marketing team has made significant strides in adding efficiency to our user experience, by customizing our messaging, improving our retargeting programs in a more sophisticated segmentation scheme, and enhancing online recommendations through suggested purchases and on-site search recommendations. As a result of this, conversion rates, defined as approved customers with purchases, are significantly up year over year. Additionally, customers who purchase are using more of the credit granted as demonstrated by a 25% higher average order value from last year. These efforts are resulting in an offset of the lower approval rates by our tightening, by dramatically improving efficiency within our sales funnel. As we look at early trends in Q3, we are seeing positive year-over-year lease comps in both our partnership and marketplace channels in July. We are also seeing healthy repeat customer engagement within our marketplace. It is important from a credit quality perspective as repeat customers repay at a better rate than new customers. We are observing increasing repeat rates with a higher percentage of new customers making subsequent purchases on our marketplace this quarter compared to last quarter. We are constantly monitoring payment performance and making adjustments as conditions warrant. The advantage of our leased product is we quickly see improvements or deterioration in credit performance in comparison to the slower feedback loop from credit cards, auto loans, or mortgages. This allows us to quickly adjust credit policy as conditions worsen or as conditions improve with more timely performance measurement. Additionally, the investments we made in our decision science team are paying dividends as new underwriting tools are quickly deployed with the latest data, making our underwriting strategy more targeted than before. Being able to both grow revenue while at the same time keeping credit quality stable is a key goal of the team. Turning to our lending initiative, originations were up significantly from last quarter, with $12.9 million in Q2 versus $5 million in Q1. As is the case with our lease business, we continue to be very prudent in our underwriting standards for the loans business. Our decision science team has also been hard at work in building new risk and marketing to be able to further grow this business profitably. Loans have a large addressable market as this product expands the type of retailer we can do business with beyond the seller of hard goods. We are also able to effectively leverage our operating platform with minimal increases to our non-marketing SG&A expense to manage and grow our loan strategy. We plan on growing this channel cautiously by keeping both acquisition costs and credit risk in check as we grow through the rest of this year. In summary, we are seeing improving dollar volume with the expansion of both our loans and lease businesses, while at the same time keeping a tight underwriting standard in place to guard against the impacts of inflation on our customers. As we continue to optimize our user experience, our modeling and statistical tools, and we expand our distribution networks to both lease and loan products, we will be well-placed to take advantage of an uptick in consumer confidence as inflation decreases. With that, Let me turn the call back over to Rich.

Thanks, John. In closing, I would like to summarize our strategy, which can be defined as profitable growth with a disciplined view of credit risk. The management team understands we continue to operate in an uncertain economic environment, and we will continue to closely monitor our customers' payment behavior. We believe diversified lines of business will enable us to grow in the future irrespective of the economic environment. For a long time, our omnichannel approach to listing has provided some diversity. Additionally, as John mentioned, our new lending initiative opens up a new avenue for growth. Finally, the newest source of profit growth is our retail sales initiative. This initiative is built on direct partnerships with manufacturers and distributors who provide us merchandise at wholesale prices. We sell these products at retail prices and capture the retail profit margin. Obviously, FlexShopper.com is a retail environment, and over time, we have become proficient at online retail marketing. Historically, the vast majority of our profits from the marketplace have been derived from the earnings we make from the lease transaction with very little profit from the retail margin. FlexShopper has great relationships with our existing retail partners. They support us with access to inventory and delivery to consumers, and we support them through creating incremental sales. In many cases, our retail partners have unique or hard to find items that our customers would not be able to access otherwise. We plan to continue growing and nurturing those relationships. However, there are many items that are a bit more common, such as furniture, bedding, jewelry, et cetera. We currently have a relatively small penetration rate in our marketplace for these types of consumer goods, and we would like to fill that gap. Over the past year, we have put together a small team of experienced retail professionals to focus on this initiative. And we have signed over 40 wholesale partners Selling the products provided by these partners greatly increases the retail profit margin to FlexShop, making our marketplace a more profitable investment for the company. In the second quarter, we began testing the sell of these products on the marketplace, and the initial results are promising. Like lending, this retail line of business is complementary to what FlexShopper has done in the past, and therefore does not require a significant incremental investment. In conclusion, we strongly believe diversifying our revenue streams through complementary business lines, which now include leasing, lending, and retail sales, creates a scalable platform for the continued growth of Flex Shopper. Thanks for your time. We are bullish about the opportunities in front of us and what they mean for the company and its shareholders. We are now happy to answer any questions you may have at this time.

Thank you, sir. Ladies and gentlemen, we would now be conducting a question and answer session. If you would like to ask a question, please press star and then 1 on your telephone keypad. A confirmation turn will indicate that your line is in the question queue. You may press star 2 if you would like to remove yourself from the question queue. For participants making use of speaker equipment, it may be necessary to pick up the handset before pressing the star keys. The first question comes from Scott Buck of H.C. Wainwright.

Good afternoon, guys. Good morning, I guess. Thank you for taking my questions. First, Russ, do you mind writing through those numbers again on store counts, where you are and where you'll be at the end of the year?

Sure. No problem at all. We started the year With about 1,250 doors, expect to add about 1,600 or so and end with about 3,000 active doors. And then I mentioned additional current partner where we're expanding with our loan program and we'll add another 500 doors by the first quarter of next year.

Okay, so we're basically looking at, you know, being triple the store count a year from now, right? 35 versus 1,200 or so. That's great. Do you mind talking through individual store economics? I mean, how should we think about the value of each incremental door that you guys add? Do they generate XX number of leases a year? I mean, what's the right way to think about it?

Sure. From our perspective, it's you know, being an active door requires at least one lease per week, but we should think about each of these doors as adding at least $5,000 in leases per month.

Okay, that's very helpful. And then turning to the loan product a real meaningful jump, you know, sequentially, which makes sense given the kind of wider role. What's the longer-term opportunity? I mean, should we expect growth like this over the next several quarters? Or, you know, are you a quarter in, you tap the brakes and kind of see how things go and, you know, I guess how do you control the growth here?

I'm going to hand this one off to John Davis.

Yeah. Yeah, hi there. The percentage increase from Q1 to Q2 was certainly significant. While we see growth from the, you know, the 12 some odd million dollars we originated in Q2, it won't be at the same levels. You know, it will grow in conjunction with the increasing door count. because what we're going to do is deploy both lease or loan depending on the kind of retailer that we have. So as it grows, it will increase from current levels, but it won't be at the same sort of percentage increase you saw in Q1.

Scott, let me add a little extra context to that. As we have mentioned, we started this lending program well over a year ago, and we were in testing for quite a while. We got comfortable with the lending program and accelerated into the second quarter of this year, as we mentioned last quarter. As I spoke about a couple of times in prepared remarks, we are in an uncertain economic environment. And so, while we want to expand in conjunction with our storefronts, as John mentioned, We're also keeping our eye on the economic environment and closely monitoring the early results of any lending we do. So we are going to continue to grow. We think we'll continue to have good results, but we will be operating under the capacity level we would be able to operate under in a more normal economic environment.

Great. That's helpful, guys. And then last one for me, if you could just remind us, you know, given the environment we're in, how quickly you're able to adjust underwriting standards on both the loan and the lease product.

Yeah. No, this is John again. From a technical perspective where we have a lot of ability to be very nimble when it comes to enacting new credit policies. The enhancements to our decision sciences team have also allowed us to quickly rebuild statistical tools, credit models, et cetera, to take advantage of the most current data. From reacting to the macroeconomic environment, we'll be cautious. We have seen what looks like some moderation in the increase in inflation very recently, but it's still, I think, way too early to react to those early data points. So we'll continue to monitor credit performance as we go through the next few months. As I mentioned in my prepared remarks, the lease and loan products provide fairly quick credit KPIs. that do allow us to be more nimble in making changes versus a credit product that takes a lot longer to evolve. So we can't react to those quickly, but we're still going to be fairly cautious and observe conditions over the next few months.

I think, John, you did a great job of answering the question that Scott asked. Let me answer a question you didn't ask, Scott, which is, Once you make those changes, how fast can they really make an impact? One of the features of our lending and lease products is they have a relatively short duration. So once you do make changes, in this case we've been tightening the credit policy, you begin to see within a relatively short time period a pretty good impact on the overall performance of the total portfolio because of the short duration of each asset that we produce with a new loan or a new lease.

Great. That makes sense, guys. I guess I'm going to sneak one more in here. In terms of your underwriting standards, I know we're tighter than we were a few months ago, but can we put some more historical context around it? I mean, where are you versus pre-COVID? Where are you versus the last, you know, significant macroeconomic, I don't know, recession is the right word, but last time there was a significant macroeconomic pressures on the business.

Well, let me answer the latter question because that's easier. And then I'll turn the harder question over to John and give him some time to think about that. And this company hasn't really been through a previous recession, so to speak, right? So it's difficult to compare it back to, say, the last time we saw significant impact like this. I was in another company dealing with this, which was, you know, the financial crisis. So we really can't answer that question. But I think John probably can give you a feel for the relative tightening level, if you will, where we are now versus pre-COVID. So, John, I'll turn that to you.

Yeah. You know, I think if you could index, you know, the level of, tightness, if you will. We haven't been this tight since the very beginning of the pandemic in Q2 of 2020, where there was a ton of uncertainty around what was going to happen with the U.S. consumer and economy shutting down. So we're certainly tighter than we were pre-pandemic. We're almost as tight as we were at that very beginning of the pandemic before we had visibility of what was happening. So we are certainly very cautious in our underwriting standards, which is why I'm especially pleased to see sequential growth in our lease volume despite having those credit levels.

I would say that for those of you who have followed the company for a while, I came here in the fall of 2019, and one of the first things we did, if you'll look back at conference calls, transcripts, et cetera, is we did some tightening at the end of 2019. And I would say that where we are now is roughly equivalent to where we were at that point in time.

Great. Well, I appreciate the additional color, guys, and congrats on the quarter. Thanks. Thanks.

The next question comes from Michael Diana of Maxim Group.

So, Rich, welcome back. Thank you. I just want to make sure I understand what you're calling retail. So from what you said, I think it's a lease product. It's mainly through your marketplace channel. And you're really going beyond consumer electronics into things like furniture, jewelry and all. Are those things right? And am I leaving out some important things?

I think maybe that requires a little more clarity on my part. We operate FlexShopper.com, which is our marketplace, and it's our retail presence. And obviously we have retail partners on that marketplace. And historically, the vast majority of our profitability is from the marketplace has been through our lease economics. A retailer sells something, we offer the lease to the consumer, we buy the product, we lease it to the consumer, and we get the economics from leasing. We, over time, have tended to have a penetration rate more on electronics and specialty goods such as that. Um, obviously the United States retailer, uh, the United States consumer consumes much more than just that. And we wanted to fill some gaps. So we have, uh, we started studying this, uh, about a year and a half ago, and we wanted to move into some more common products such as, um, household goods, bedding, furniture, even jewelry, et cetera, where we had limited, um, volume on our marketplace. Rather than doing that, what we've chosen to do is we've partnered with wholesale partners, and we are buying directly from those partners at a wholesale price and then marking up to the retail price, which enables us to capture the retail margin. It's like a normal retailer would. So in this case, this new line of business, which we just launched and we've tested with some degree of success in the second quarter, enables us to derive profitability from the retail sell itself, as well as the profitability from the lease that finances that retail sell. Does that make sense?

Yeah, of course. Are you doing it for your existing consumer electronics, or is this just for these new products you're selling?

It's primarily for the new products. I mean, the products we're selling with our existing partners in the electronic space, that business is going very well, and we're going to, as I said in prepared remarks, We're going to continue to nurture and grow those relationships. Those are working very well for us, and we're very pleased with that. And our partners seem to be very pleased as well.

Okay. So I guess what you're saying on the newer endeavor, the margins should be bigger.

Our testing indicates that in the future we should be able to capture more retail margin on our marketplace. That is... a relatively new endeavor, so we don't have any further insight as to how large that could be, but it is something that has evolved to the point that we thought we would speak about it as a diversified line of business.

Okay, great. That's very helpful. Thank you.

Ladies and gentlemen, we have reached the end of our question and answer session. I will now turn the call over to Rich House for closing remarks.

Well, thank you, everyone, for your time this morning, and we look forward to speaking to you next quarter.

Thank you. Ladies and gentlemen, that concludes today's conference. Thank you for your participation, and you may now disconnect your lines.