Open Lending Corporation

Good afternoon and welcome to the Open Lending's fourth quarter and full year 2022 earnings conference call. As a reminder, today's conference call is being recorded. On the call today are Keith Jesick, CEO, and Chuck Yale, CFO. Early today, the company posted its fourth quarter and fiscal year 2022 earnings release and investor supplement to its investor relations website. In the release, you will find reconciliations of non-GAAP financial measures to the most comparable GAAP financial measures discussed on this call. Before we begin, I'd like to remind you that this call may contain estimated and other forward-looking statements that represent the company's view as of today, February 23, 2023. Open Lending disclaims any obligation to update these statements to reflect future events or circumstances. Please refer to today's earnings release and our filings with the SEC for more information concerning factors that could cause actual results to differ from those expressed or implied with such statements. And now I'll pass the call over to Mr. Keith Jessick. Please go ahead.

Thank you, Operator, and good afternoon, everyone. We appreciate you joining us today for Open Lending's fourth quarter and full year 2022 earnings conference call. Before we begin, I would like to express my continued confidence in the long-term opportunities before us. The actions and behaviors of consumers, auto lenders, OEMs, and dealerships, and the corresponding pricing dynamics we have experienced are not without precedent. However, what's notably different in this cycle is the impact of the velocity and the magnitude of the Federal Reserve rate increases to the auto industry, and more specifically, to consumer affordability and lender liquidity. Having managed skilled businesses in the auto sector through the Great Recession, as well as serving on the Open Lending Board during this time, I'm encouraged by the response of our team, and I'm confident in our ability to manage through the current challenges. I'll speak more about how we are positioning the company to continue to gain share given our financial strength, our value proposition, and our competitive position after reviewing our results. For the year, we certified over 165,000 loans, a slight decrease from the previous year. Total revenue for the year was $180 million, down 17%, and at the lower end of our guidance. Adjusted operating cash flow for the year was $143 million, which was near the high end of our guidance. Now let's spend a few minutes on recent industry trends and expectations for 2023. First, on inventory. As many of you know, used vehicle sales in 2022 tumbled to their lowest levels in nearly a decade. Supply chain and chip shortage constraints have improved year over year, but sales for new autos remain well below historical levels as well. Second, on affordability, we believe this will remain the most significant challenge for us in the near term. The intended consequences of the Federal Reserve's rate increases in 2022 and 2023 are impacting the auto sector and our current addressable market. Near and non-prime consumers are being hit disproportionately by rising rates, resulting in lower disposable income. As the Fed continues a path to reduce inflation, a more expensive auto payment driven by higher rates is dampening demand. For example, the weighted average auto loan rate for both new and used vehicles in subsegments is up 200 to 300 basis points. Next, on loan originations, in speaking with the Treasury teams at credit unions and other financial institutions, they currently have alternatives for balance sheet capital in short-term duration instruments as well as risk-free bills, notes, and bonds in the Treasury markets. To the extent these alternatives are more attractive, liquidity within the auto-origination pool of capital is reduced. Callahan data shows total loan originations were about $160 billion in the fourth quarter of 2022, down 21% from a year earlier, and down 19% sequentially from the third quarter of 2022. In the peak of the pandemic, when liquidity was high and federal stimulus relief was running rampant, Credit unions held about 12 to 13 percent of their assets as cash, which was easily available to fund new loan demand. Now, credit unions on average are down to approximately 6 percent of their total assets in cash. Some of our largest credit unions have a loan-to-share ratio in excess of 100 percent. This reduction in liquidity has impacted the borrowers who are most in need and have been hit hardest by inflationary pressures to their rent, food, energy, and transportation. Finally, our refinance business made up 43% of our certified loan volume at its peak in February of 2022, but has declined to 11% in December 2022. This business has been severely impacted by the unprecedented Federal Reserve actions throughout 2022 and now into 2023. Again, this constitutes a significant impact on affordability of our near and non-prime borrowers. Based on prior cycles, it's our sense that when rates begin to stabilize, we should begin to see improvement in this part of our business. In summary, the industry backdrop for the auto loan sector is experiencing historic challenges. That said, we believe these challenges will be temporary. We remain committed to our goal of gaining market share, and we expect to be well positioned to meet pent-up demand as the industry recovers. With that in mind, I want to discuss our areas of focus as we move throughout 2023 to position us well for this year and beyond, areas which I believe will support and strengthen our long-term competitive advantages. First, we look to further refine and optimize our sales channels. Second, we will continue to enhance our technology offering. And equally as important, we are laser focused on attracting and retaining talent. Now to go into each area in a little bit more detail. First, sales, operations, and marketing. To power our go-to-market efforts, we increased our sales, marketing and account management teams by nearly 30% in 2022, and we plan to continue to thoughtfully invest in these areas throughout 2023. We will keep a watchful eye on these investments, measure performance, and ensure that they deliver the expected returns. To strengthen our team's future success, we organized our team into one group dedicated purely to selling, while the other focuses solely on account management. In short, we have aligned our efforts to maximize our sales efficiency. Our experienced sales team will continue to work primarily on closing new accounts. Their efforts will be aided by our expanded marketing team, which is supporting sales with a robust lead generation program to help secure new business. We are early in this initiative, but you may have already seen our earned media coverage in the Wall Street Journal, Automotive News, Auto Remarketing, Auto Finance News, Credit Union Times, and Payments.com. These are publications that decision makers read daily. so we believe this will further support our sales team. To lead these efforts, we've added a new senior vice president of marketing to our leadership team. We are encouraged by our strong December sales, as well as other recent wins, including the addition of Crescent Bank, a top 50 bank auto lender in the U.S. Our account management team will center their attention on continued engagement and collaboration with our customers with the simple priority of building our base of business from existing customers by expanding their use of our program. We've launched various targeted customer promotions via multiple channels, and we have produced a number of thought leadership pieces, including a highly attended National Association of Federal Credit Unions webinar on loan securitization. We have improved our implementation process and shortened the time to go live for a new institution. We've also added a Senior Vice President of Operations to improve client retention and drive operational best practices. While still early, We have seen significant progress from these investments. For the full year 2022, our non-OEM business, primarily credit unions, was up 16% driven by strong refinance volumes earlier in the year, while in contrast, the large universal banks reported auto loan originations down 25% to 30% year on year. Now let me turn to our technology. We continue to have a distinct competitive advantage with significant barriers to entry given our 20-plus years of proprietary data sophisticated technology, including five-second underwriting decisions, exclusive relationships with A-rated insurance partners, deep lender relationships, and regulatory know-how. And we will continue to strategically invest in our lenders production technology to remain a best-in-class risk-based solution for lenders seeking to serve non-prime customers. To make car ownership more accessible for those in near and non-prime credit segments, we increased our allowable vehicle age from 9 to 11 years. One of the criteria we set forth in conjunction with this modification was very specific mileage caps as determined by our proprietary data set of auto evaluations. With the average age of finance vehicles jumping from 5.4 to 6.4 years for FICO scores below 640, this change allows financial institutions to grow their portfolios while minimizing risk through Open Lending's default insurance and risk management program. Equally as important, vehicles 10 years and older comprise some 8% of all used car purchases. We've also expanded our loan approval expiration window from 30 days to 45 days for our direct and refinance channels. This change offers our customers and refinance partners sufficient time needed to complete their respective funding processes. To support our go-to-market strategy enhancements and streamline onboarding of new customers, we recently expanded our integration to three new technology partners. And lastly, as we strive to lower delivery costs and improve integration timelines, we continue to modernize our infrastructure with cloud computing technologies. We welcomed our new chief information officer in November to focus on our migration to the cloud, as well as on driving security, data integrity, DevOps, and IT operations. He joins us from AmeriFirst Home Mortgage and brings a wealth of industry and technical experience. We are confident that our technology investments allow us to improve our time to market for developing, testing, and developing secure applications that enhance customer satisfaction. Lastly, we are also committed to attracting and retaining talent, creating a best-in-class organization. To lead these efforts, late last year we announced the appointment of a chief human resources officer focused on building a strong people strategy to support and expedite open lending's mission. We expect to continue driving company culture centered on creating a diverse and collaborative environment to unlock value and foster growth for individuals, teams, and the business. To wrap up, I couldn't be more excited about our opportunity, now having almost five full months in the CEO seat. This is driven by the fact that we continue to have a large and growing total addressable market, a profound competitive advantage, and significant barriers to entry with our people and technology, as well as a business model that leverages both of these points. We are focused on areas that we are confident will position the company for success for years to come, With that, I would like to turn the call over to Chuck to review Q4 and the full year in further detail, as well as to provide our thoughts on 2023 outlook. Chuck?

Thanks, Keith. During the fourth quarter of 2022, we facilitated 34,550 certified loans compared to 42,639 certified loans in the fourth quarter of 2021 and 42,186 certified loans in the third quarter of 2022. Total revenue for the fourth quarter of 2022 was $26.8 million, which includes an ASC 606 negative change in estimate of $12.8 million associated with our profit share, compared to $51.6 million in the fourth quarter of 2021. When excluding the impacts of ASC 606 change in estimate from both periods, revenue during the fourth quarter of 2022 was only down $5.5 million, or 12% year-over-year. To break down total revenues in the fourth quarter of 2022, profit share revenue represented $6.1 million, program fees were $18.3 million, and claimed administration fees and other were $2.4 million. It is important to note that while our certified loan volume was down in the fourth quarter of 2022 from the fourth quarter of 2021, our program fee revenue only decreased slightly due to mix of business certified, which resulted in higher unit economics. Turning to profit share. I want to remind everyone that profit share revenue is comprised of the expected earned premiums, less the expected claims to be paid over the life of the contracts, less expenses attributable to the program. The net profit share to us is 72% and the monthly receipts from our insurance carriers reduce our contract asset each period. To further discuss the 6.1 million in profit share revenue in Q4, the profit share associated with new originations in the fourth quarter of 2022 was 18.9 million or $546 per certified loan, as compared to $24.7 million, or $580 per certified loan in the fourth quarter of 2021. As mentioned previously, we recorded a negative $12.8 million change in estimate as a result of an expected decrease of profit share in future periods due to higher than anticipated claims frequency and severity of losses. Notably, this was partially offset by lower anticipated prepaids due to the elevated interest rate environment. The Mannheim Used Vehicle Value Index, which tracks the prices car dealers pay wholesale at auction for used cars, is one of the macroeconomic factors we consider in evaluating our change in estimate each period end. This index fell nearly 15% year-over-year. That's the largest one-year decline in the history of the index. However, it's worth noting that it remains highly elevated compared to prior 10-year trailing levels and therefore continues to impact auto affordability. In comparison, during the fourth quarter of 2021, revenue included a positive $6.5 million change in estimated future revenues on certified loans originated in historical periods. This was primarily due to a positive realized portfolio performance attributable to lower frequency and severity of claims. Gross profit was $21.9 million, and gross margin was approximately 82% in the fourth quarter of 2022. As compared to $46.9 million and gross margin of approximately 91%, in the fourth quarter of 2021. For the quarter, the gross margin excluding ASC 606 negative change in estimate would have been 88%. Selling, general, and administrative expenses were $17.2 million in the fourth quarter of 2022 compared to $11.7 million in the fourth quarter of last year. The increase year-over-year is primarily due to additional employees to support our growth with a focus on our go-to-market sales strategy and investment in our technology as previously discussed by Keith. Operating income was $4.8 million in the fourth quarter of 2022 compared to $35.2 million in the fourth quarter of 2021. Net loss for the fourth quarter of 2022 was $4.2 million, which was driven by the $12.8 million negative adjustment to our profit share contract asset compared to net income of $27.8 million in the fourth quarter of 2021. Basic and diluted earnings per share was a loss of 3 cents in the fourth quarter of 2022 as compared to 23 cents in the previous year quarter. Adjusted EBITDA for the fourth quarter of 2022 was 8.5 million as compared to 36.6 million in the fourth quarter of 2021. There's a reconciliation of GAAP to non-GAAP financial measures that can be found at the back of our earnings press release. Adjusted operating cash flow for the quarter was 33 million as compared to $38 million in the fourth quarter of 2021. We exited the quarter with $380 million in total assets, of which $205 million was in unrestricted cash, $75 million was in contract assets, and $65 million in net deferred tax assets. We had $167 million in total liabilities, of which $147 million was outstanding debt. During the fourth quarter, we announced the authorization by our board of directors to repurchase $75 million of our common stock through November of this year. This program reflects the confidence of our board and the management team in our business model, free cash flow profile, and the overall strength of our balance sheet. During the quarter, we repurchased 2.6 million shares for approximately $18 million at an average price of $6.80 per share. We expect to continue to be opportunistic in open market purchases under the current authorization throughout the year. Before I touch on guidance, I would like to update you on a change within our insurance partner relationships. CNA, a partner of ours since 2017, has decided not to renew their agreement with Lenders Protection when their term concludes on December 31, 2023, due to a shift in CNA's capital allocation priorities. We would like to thank them for their partnership over the years and their support as we work through and manage the runoff of existing policies over the coming years. As a reminder, one of our key initiatives over the past few years has been to minimize concentration risk by bringing additional A-rated insurance carriers into our program. We have successfully executed on this initiative as we have strong relationships with our three other insurance carriers to provide credit default insurance coverage to our auto lender customers. Amtrust, which is under contract through fourth quarter of 2028, American National Insurance Company under contract through second quarter of 2026, and Arch Insurance North America under contract through second quarter of 2027. We are working with all three of these carriers to transition our lender customers who had been insured with CNA to them, all of whom are interested in absorbing additional business from the Lenders Protection Program. Now moving on to guidance. If inflation were to persist through 2023, it appears the Federal Reserve will stay the course and keep rates higher for a longer period. While the bond market at times has appeared to be indicating a more favorable rate environment later in 2023, Recent forecasts from the Federal Reserve are more conservative, with current indications that the terminal Fed funds rate will be in the 6% range. These factors, as well as other macro and auto industry lending-specific indicators, are ever-changing, and more specifically, it is difficult to have visibility into financial institutions' future liquidity and the corresponding pace of auto originations. So for these reasons, At this time, we feel it is prudent to take a more measured approach by providing only a quarterly outlook. Guidance for the first quarter of 2023 is as follows. We expect certified loans to be between $28,000 and $32,000, total revenue to be between $30 million and $34 million, and adjusted EBITDA to be between $13 million and $17 million. In our guidance, we have taken the following factors into consideration. the affordability index of our target credit score borrower due to the continued inflated used car values, inflation, rising interest rates, and overall consumer sentiment. An important driver in estimated profit share is the Mannheim Used Vehicle Value Index, which we expect will continue a path of moderate declines over the next year. Also, as Keith outlined earlier, we will continue to invest this year. While this impacts our margins, we have a strong balance sheet and will be well positioned as the overall macro and auto retail industry challenges subside. We would like to thank everyone for joining us today, and we will now take your questions. Also joining us on the call will be John Flynn, OpenLineage Chairman of the Board.