FlexShopper, Inc.

Greetings. Welcome to the Flex Shopper 2022 Third Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note, this conference is being recorded. I'll now turn the conference over to your host, Carlos Sanchez of Investor Relations. You may begin.

Thank you and good morning. Welcome to Flex Shopper's third 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 on our investor relations section of our website. we will be available for Q&A followings 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 future financial performance. These should be considered in conjunction with cautionary statements contained in our earnings release and the company's most recent periodic SEC reports, including our quarterly report form 10Q for the third quarter ended September 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, net income, and 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 earning release, which is available in 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 third quarter 2022 earnings call. Once again, I will be joined by Chief Financial Officer Russ Heiser and the Chief Operating Officer John Davis. In the third quarter, we reported an EBITDA loss of $2.9 million and a net income loss of $6.3 million. In a moment, Russ will walk you through a more detailed review of these financial results. It appears the current macroeconomic environment is affecting the growth opportunities in our business more severely than we observed earlier this year. Apparently, the high inflationary environment coupled with slower economic growth has impacted the demand for discretionary purchases by the traditional Flex Shopper customer. In the third quarter, we observed a combination of lower response rates to our marketing initiatives coupled with an unfavorable risk score distribution of those consumers who did respond. Simply stated, we were attracting fewer new customers in our direct-to-consumer initiatives, and the consumers we did attract demonstrated a lower credit quality profile. The credit profile of these consumers resulted in a lower approval rate using our underwriting criteria. Last quarter, we told you we had proactively tightened our underwriting standards in order to deal with the declining economic environment. We did not tighten any further. in the third quarter, the assets we are generating are proving to be sound investments. However, because of lower response rates and lower approval rates, we are originating less of these assets than we anticipated. The bright spots in our business are proving to be the assets we are generating through our retail partnerships and our repeat customers. Retail partner volumes are up 20% year over year, and the repeat volumes continue to grow. Fortunately, the pivot to increasing our storefront partnerships that began earlier this year feeds into the areas of our business that are currently performing well, and we believe that will drive future growth. John will provide more detail regarding volume and credit quality a bit later in the call. After the updates provided by Russ and John, I will provide an overview of our immediate strategy moving forward. I will now turn the call over to Russ for a review of our financial results.

Thanks, Rich. Our third quarter financial results reflect the challenging operating environment as our customers continue to manage these inflationary conditions. Fortunately, our new growth initiatives focused on the brick and mortar channel are still on track to finish the year with more than 3,000 storefronts, as we previously indicated. As our retailer partners face their own headwinds to demand, our storefront installations are not yet maximizing throughputs. However, we still expect that originations will more than double once these installations are in place and optimized. In the quarter ended September 30, 2022, total fundings increased 60.1% to $25.8 million from $16.1 million for the same period last year. Total revenue for the third quarter of 2022 was $26.1 million, which was down 15% year over year. Gross profit was 6.4 million, or down 50% versus the same quarter last year. General and administrative expenses, which includes operating expenses and salaries and benefits, were 8.5 million, which is 1.5 million higher than the same period last year. Since October of this year, G&A has been aligned to the current economic environment, and these G&A expenses are now in line with last year. Adjusted EBITDA was negative $2.9 million, a decrease of $7.8 million year over year. I'll now turn it over to John to discuss our operations in more detail.

Thanks, Russ. Economic conditions remain challenged for our customers. Customer inflation, as measured by the Consumer Price Index, has plateaued in June of this year, but has not yet moderated and is holding at an 8% annualized rate. At the same time, hourly wage growth is approximately 5%, which is resulting in deterioration in customer disposable income. Unemployment rates remain low, but the significant increase in short-term interest rates are predicted to slow down economic growth in the future, which puts future employment levels at risk. This economic backdrop has restricted the spending activity of our good customers as they rationalize their personal balance sheets. which has resulted in a slight drop in overall lease originations year over year with a 1.9% decline. When split between our marketplace and partnership channels, our marketplace originations were down over 20% year over year, and our partnership originations were up over 20% year over year. As a reminder to those listening, we originate leases through our proprietary marketplace that can be found online at FlexShopper.com and through point-of-sale retail partnerships as a secondary financing option for those customers. Addressing our marketplace channel first, our underwriting standards remain significantly tighter this year in comparison to last year. Marketplace application volumes are down 5% from last year, but approval rates this year are 52% lower than last year as tight underwriting standards remain in place. We are also observing some deterioration in the applicant credit quality as measured by generic credit scores that we obtain during our underwriting process, which is also contributing to lower approval rates. Despite this quality drift in our marketplace channel, our tighter standards do appear to be effective based on our early default rate trends, which are 18% better year-over-year, even with the significant difference in economic conditions. We will continue to be prudent in our approval criteria in order to maintain these default rates. which are a good early indicator of the eventual return on mature originations. As we continue to keep lower year-over-year early default rates, our bad debt reserve ratio will follow as these vintages season into the calculation. We also continue to experience nice average order value growth, stronger year-over-year conversion rates on approved applicants, and strong repeat customer leasing rates, which are partially offsetting the much lower approval rates we are experiencing. Maintaining asset quality has never been as important as it is right now in the history of the company, and we will remain cautious as we observe how consumer prices and employment rates progress over the short term. We also, at some point, expect better credit quality customers to come to FlexShopper in the future as credit availability with lenders above us in the credit spectrum tighten their standards. We have not yet observed this, though, and are managing our underwriting standards, assuming that this is not going to occur in the short term. Moving on to our partnership channel, we are benefiting from more origination volume from our recent door expansion, as well as higher volume from established partnerships. Even with slightly lower approval rates year-over-year within our partnership lease channel, we are seeing 11% application growth and 23% year-over-year growth in average order value. We continue to have a strong pipeline of new door fronts that will drive future revenue growth. Also importantly, we are seeing 10% lower year-over-year early default rates, so we are comfortable with the asset quality and the growth we are seeing within this channel. With the future expected growth in door counts, as well as trends we are seeing within existing partnerships, we expect that this revenue growth will continue while maintaining favorable credit quality. Looking at our loan bank partnership product, our bank partner originated approximately $10 million in Q3 of this year versus approximately $400,000 last year in the same quarter. However, bank partners' originations are sequentially down from the approximately $13 million originated in the second quarter. Like all of our other originations and purchases, we are being very vigilant on our underwriting standards and are prioritizing asset quality above revenue growth in the current economic environment. Similar to our lease product, We are also seeing success with this strategy within the loan product with early pay default rates on loans originated by our bank partner in Q3, lower than both Q2 as well as Q3 of last year. With some of the new partnership marketing deals recently announced, there will be opportunities to grow the loan product in the future, but this will be done in a way that continues to preserve asset quality of what is being currently originated or purchased. Lastly, we are making progress on our retail strategy. Last quarter, Rich spoke about introducing products on FlexShopper.com sourced from manufacturers and distributors to make both a retail margin as well as our traditional margin on product financing. This has started to roll out onto our marketplace with a 5% balance of sale at retail margins in the high 30% range in Q3. We are selecting products that are complementary to our existing marketplace partner selections which allow our customers to utilize their approved spending limits more fully with a wider selection of goods. This additional margin has the potential to be a powerful improvement to profitability as the volume of these sales increases and becomes a larger mix of overall revenue. In summary, we will continue to prioritize asset quality over revenue growth as economic conditions remain challenged for our customer base. I am pleased with the origination growth we are seeing within our Partnership Lease channel and I'm encouraged by the low early default rates we are seeing across all parts of our business. As economic conditions strengthen, FlexSharper will be well poised to drive sustainable, high-quality growth across all of our distribution channels. With that, let me turn the call back over to Rich.

Thanks, John. In closing, our strategy has not changed. We continue to pursue profitable growth with a disciplined view of credit risk. Our plan was for the growth in our direct consumer business to provide a bridge of growth leading to far more future volume growth through our significant doorfront expansion with retail partners. Unfortunately, the aforementioned decline in response rates and approval rates has created a gap in our near-term earnings, but it does not change the fundamental strategy. We're going to continue to press forward with our retail storefront strategy which most recently is highlighted by the announcement we made in October regarding our exclusive marketing partnership with Liberty Tax. As a reminder, this new partnership establishes FlexShopper as the exclusive financial services provider for more than 2,000 storefront locations for Liberty Tax in the United States. We anticipate providing financial products to these consumers who largely match the demographic profile of the traditional FlexShopper customer. In addition to the storefronts, we also plan to use Liberty's growing online presence, including their website and the Liberty Tax app, to distribute Flex Shoppers products. We are hopeful we will enjoy some benefits from the online Liberty presence over this upcoming holiday shopping period, and we look forward to significantly benefiting from expansion into the storefronts as we move into the 2023 tax season and beyond. Our other significant retail partnership growth opportunity is based on aggressively expanding the door front service with an existing partner who is focused on tire sales and automotive services. In addition to the retail partner expansion, we continue to be committed to the wholesale retail strategy John discussed earlier. Increasing our retail margins through partnerships with manufacturers and distributors will enable us to improve the profitability of our online marketplace, FlexShopper.com, irrespective of how the new leases are originated, either through retail partnerships or directly to consumers. It is difficult for us to know when the macroeconomic environment will improve. Therefore, we're going to maintain a very disciplined approach to credit risk, and we're going to reduce our costs to match the current level of fundings we are currently observing. As of the end of October, we have made substantial reductions in expenses associated with employees and many of our outsourced technology partnerships. We anticipate our base-level operating costs, excluding marketing, to be approximately 10% lower in 2023 than 2022. Our view is that minimizing our cost structure, maintaining credit discipline, and expanding our retail partnership network will enable us to push through the current macroeconomic environment and grow rapidly and profitably as the economy improves. Thanks for your time. We are well aware of the challenges associated with the current environment, but we are bullish regarding the long-term prospects for FlexShopper shareholders. We will now answer any questions you may have.

And at this time, we will be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. One moment, please, while we poll for questions. And our first question comes from the line of Scott Buck with HC Wainwright. Please proceed with your questions.

Hi, good morning, everybody. I'm curious, Rich, as these challenges kind of move through the fourth quarter here, how should we be thinking about, you know, demand just given the seasonal strength of the quarter historically? I mean, is Christmas canceled this year?

I'm not canceling Christmas. I'm not the Grinch. You are correct in that we normally see a seasonal increase in our volume We continue to believe that will happen. It's difficult for us to predict what that will be. We're going to continue to market online and try to drive people to our marketplace. We're not giving up on that, but we're cautious regarding the amount of volume that may be there, and that's why we've gone ahead and made some adjustments to our cost structure We're hopeful that we get a volume boost from the holiday season, but it's certainly something I think we can be certain about.

Great. That's good color. I'm curious on the competitive landscape. Are you seeing any actions or behavior by competitors that may be making some of the headaches that you're dealing with worse, or is everybody really in the exact same boat here?

It's difficult for me to see what the competitors are doing. I do, like you, I'm sure, read their press releases, and they all seem to be talking about many of the same things we are in that the credit quality, the profile of people who are applying for credit appears to be unfavorable compared to times in the past. And so I think everyone is experiencing more declines and lower volume as a result of everyone exercising a reasonable amount of credit discipline.

Okay. So you're not seeing folks kind of move down the credit chain into your, you know?

No, we have not seen that. We have not seen that. In fact, we're going to speculate. I think John mentioned in his commentary, we speculate that lenders above us in the credit spectrum will tighten, and if history repeats itself like it did in the past recession, then that should increase our volume over time because as people lose the liquidity they may be getting from lenders above us in the credit spectrum, they would naturally drift down into our space. Unfortunately, we have not seen that phenomenon yet, but that is something that that we would generally anticipate, but we are not planning on that. Once again, we're getting our cost structure in place as if that will not happen.

Yeah, no, that makes sense. And then last one for me, just on some of those cost reductions, if this environment were to extend for a significant period of time, do you guys have a little bit more room to cut? Or do you feel like you've kind of gone through the muscle at this point and you're down to the bone?

I think we've made the cuts where we need to make them. We were looking at some new initiatives. As any enterprise would, you look at what you're doing currently and what you may do in the future. We are not cutting back on what we're doing today. We're probably going to, after the holiday season, really make sure that we justify all of our marketing dollars in this environment, but we're not really talking about marketing cuts in this particular expense reduction. Marketing will adjust according to the market, okay? But as far as expense reductions go, I think we've probably cut what we need to. And keep in mind, and I may not have been clear enough in my commentary, We are very bullish about our retail expansion. And while we're seeing significantly lower approval rates in our direct-to-consumer marketing efforts, we're not seeing that same phenomenon in our retail partners. So as we roll out these retail partners, we believe we'll move back into a growth mode relatively quickly in the coming year.

Yep, that makes sense. And if I could squeeze one more in, I just want to confirm, it sounds like you guys will be up and running in all the Liberty Tax locations by the time tax season rolls around in January, correct?

That is the game plan, the specific game plan with Liberty Tax is because of the holiday season you mentioned, we're working very hard to enable our marketing efforts on their digital channels right now. We want to get that in place prior to this current holiday season. At the same time, we have a separate team working with Liberty Tax to begin mobilizing to get into their storefronts as we move into the tax season. And as you know, with the Liberty Tax profile, that tax season starts pretty early. So we have a team mobilized right now to begin rolling out into the Liberty Tax store system beginning in January.

Okay, perfect. I appreciate the time, guys. Thank you.

Sure.

And it looks like we have reached the end of the question and answer session. I'll now turn the call back over to Rich for closing remarks.

Thank you very much for joining us today, and we will talk to you guys next quarter.

And this concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.