Open Lending Corporation

Good afternoon and welcome to Open Lending's second quarter 2023 earnings conference call. As a reminder, today's conference call is being recorded. On the call today are Keith Jezik, CEO, and Chuck Yale, CFO. Earlier today, the company posted its second quarter 2023 earnings release and supplemental slides to its investor relations website. In the release, you will find the 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, August 8, 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 Jezik. Please go ahead.

Well, thank you, Operator, and good afternoon, everyone. Thank you for joining us today for Open Lending's second quarter 2023 earnings conference call. I am pleased to announce we exceeded the high end of our Q2 guidance range for all metrics, certified loans, revenue, and adjusted EBITDA. During the quarter, we certified 34,354 loans, generated total revenue of $38.2 million, and adjusted EBITDA of $20.7 million. I would like to thank all of our team members at Open Lending who executed and delivered these positive results despite challenging sector and macroeconomic conditions. As we know, the auto industry continues to navigate through multiple challenges. As of June, there were 1.9 million new vehicles on dealer lots or in transit, representing a 75% increase compared to a year ago. While this is a significant year-over-year increase, these inventory levels are still well below pre-pandemic levels of approximately 4 million units. The improved availability of supply led to an increase in the new vehicle SAR to 15.7 million units at the end of July, up 5% sequentially since March 2023, and 15% higher than a year ago. Despite this increase, total new sales remain approximately 10% lower than pre-pandemic levels of approximately 17 million units. This improvement in New START was bolstered by average transaction prices in July declining 0.7% versus June of 2023. In addition, OEMs are continuing to increase incentives, which reached the highest levels since late 2021. We are encouraged by these metrics and progress as they are an indication of a return to pre-pandemic conditions, which are more advantageous to the consumer. Now let's turn to used auto. Used vehicle SAR ended June at 36.7 million units, up 7% sequentially since March 2023, and almost 3% higher than a year ago. However, this result remains 9% lower than pre-pandemic levels of approximately 40 million units. As the industry continues to deal with the supply-constrained environment, retail prices have declined only 3% to an average used vehicle price of approximately $27,000. This is still close to 40% higher than pre-pandemic levels, creating continued affordability challenges for the near and non-prime consumer. Understandably, consumers are holding onto their vehicles longer than historical periods, with the average age of a passenger car on the road now exceeding 13.5 years. As cars age, The typical consumer is at risk for major repairs versus just routine maintenance costs. Accordingly, we believe there is a significant pent-up demand within the used auto market, creating a great opportunity for which we will be well positioned as the sector and macroeconomic conditions improve. Shifting to affordability, it remains the most significant challenge for the near and non-prime consumer and ultimately our business. Cox Moody's Vehicle Affordability Index reported the median weeks of income needed to purchase a new vehicle in June decreased to 43 weeks down slightly from 44 weeks in December. Even though this is moving in the right direction, it is still much higher than the historical average of approximately 35 weeks. While auto prices have slightly decreased, financing costs have not as borrowing costs remain elevated due to the continued tightening actions by the Federal Reserve. For example, The average used auto loan interest rate increased to approximately 13.5%, while the average new auto loan interest rate exceeded 9% for the first time in over a decade. As we have seen in prior cycles, as supply returns, vehicle prices are expected to moderate and interest rates are likely to decline, which should lead to improved affordability for the near and non-prime consumer. Now let's turn to our credit union customers who, as you will recall, became the market leader of all auto loan originators in Q3 2022, reaching 28.4% market share. However, over the past three quarters, they have shrunk their market share due to continued liquidity challenges. We have seen credit unions tighten their underwriting standards in this environment, and most recently they turned their focus to prime and super prime borrowers. In fact, Fed data reflects auto loan originations in the 620 to 719 FICO band decreased 21% from Q4 2022 to Q1 2023. In this environment, all lenders are being extra cautious against going too far down the credit spectrum. As a result, auto loan rejection rates hit all-time highs in June with the greatest increase occurring among near and non-prime borrows, which we serve. As market conditions improve, we expect credit unions to adjust underwriting standards in return to serving all of their members. As a company, we remain focused on positioning ourselves for the future by making measured and controlled investments with demonstrable ROI. Among these, we continue to refine and optimize our sales channels, enhance our technology offering, and attract and retain top-tier talent. First, on the sales front, we added 13 new accounts in Q2 2023 as compared to 18 new accounts in Q2 2022. Importantly, we expect to generate more certified loans from the 13 new accounts added in Q2 2023 than from the 18 accounts that were added in Q2 of 2022. This is a result of our continued focus on adding mostly larger accounts. The new accounts added during the quarter represent a doubling in the average target share to us per financial institution signed as compared to the prior period. These wins speak to the enduring and ever-growing value that open lending brings to all players in the automotive retail ecosystem. Additionally, we continue to enroll financial institutions who operate loan origination systems for which we already have existing successful technology integrations, resulting in improved mean time to revenue of over 20% on several of our recent implementations. This significant improvement in operational efficiency will serve us well as conditions improve. Now turning to marketing, we released our second proprietary research report, Loans Within Reach, Lending Enablement Benchmark. This fresh take on the automotive lending industry gathers insights from a group of US-based auto lenders to determine the role lending enablement solutions play in increasing ROA, reducing risk exposure, and improving decisioning speed. In this report, we reveal how using alternate data sources and AI-driven analytics help lenders strategically cater to near and non-prime borrowers, a crucial component of a balanced portfolio. We found that lending enablement solutions provide a clear performance advantage to financial institutions surrounding speed, growth, and personalization. The release of the report garnered tremendous earned media, including a live Bloomberg radio segment, coverage from Fintech Nexus News, Global Fintech Series, Used Car News, and Automotive Technology. This earned media and prudent investments in marketing continue to lead to a growth in marketing qualified leads. During this time, we are also making enhancements in our technology. A few highlights. First, we completed our migration to the Azure cloud, removing our dependency on legacy data center co-locations and improving our already fast decisioning response time by 25%. This important accomplishment provides enhanced stability, better performance, and reduce costs. We've already seen meaningful savings on compute and storage costs alone, and we now have scalable resources immediately available to provide services within the application without manual intervention. Most importantly, this allows us to modernize our platform architecture and automate the delivery of code more safely and securely with less development overhead. Further, our application data is more accessible to our machine learning platforms, which empowers us to streamline modeling used in decisioning and pricing auto loans. In addition to completing our cloud migration, we are making enhancements within Lenders Protection to further support our lenders' evolving needs. For example, we incorporated complex logic for decisioning, which cannot be easily changed by our lender customers within their own loan origination systems, thereby enhancing and improving their daily workflows. We also implemented enhancements that bolster our lenders' ability to provide a better direct-to-consumer digital car buying experience, such as providing a pre-qualified decision without impacting the consumer's credit score. This enhancement is critical given the industry's progress towards a digital retail transaction. As you can see with these examples, we are laser-focused on supporting and assisting our lender customers. Lastly, on talent. Hiring and retaining top talent continues to be a priority for us. We recently supplemented our executive leadership team by hiring Matt Sather as our first dedicated chief underwriting officer. Matt is an experienced insurance executive with over 30 years in specialty program underwriting at large insurance carriers. He is responsible for leading our underwriting, claims, and actuarial teams. In addition, We remain focused on building a strong people strategy that fosters a diverse and collaborative environment to support open lending's long-term growth objectives. Now I'd like to take a moment to thank John Flynn for his more than 20 years of leadership as a founder, CEO, and chairman of the Board of Open Lending. As we announced last week, John will be passing over the reins to Jessica Snyder as our new chairman of the board. It is important to note John will remain a valuable member of our board of directors, ensuring continuity and an orderly transition of leadership. Jessica, congratulations on assuming the chairman role. We look forward to partnering with both you and John in the future. As discussed, having previously managed skilled businesses in the retail auto sector through the Great Recession, I remain confident about our future opportunity as we execute on our mission to help both lenders and underserved borrowers. We are delivering on our previously outlined plans and initiatives of gaining profitable market share by only signing targeted new accounts, adding technology capabilities relevant to our customers, and most importantly, thoughtfully growing our team. Given these actions, we expect to capture the pent-up demand as the sector and macroeconomic conditions inevitably recover. Now with that, I'd like to turn the call over to Chuck to review Q2 in further detail, as well as to provide our thoughts on the outlook for Q3. Chuck?

Thanks, Keith. During the second quarter of 2023, we facilitated 34,354 certified loans compared to 44,531 certified loans in the second quarter of 2022. It is important to note that if we exclude the refinance channel volume from both periods, which as we know has been significantly impacted by interest rate increases over the past 18 months, certified loan volume was up 2% quarter over quarter. Total revenue for the second quarter of 2023 was $38.2 million compared to $52 million in the second quarter of 2022. Notably, excluding the profit share revenue change in estimate impact in both Q2 and Q1, total revenues were up 4.5% sequentially compared to Q1 of 2023. To break down total revenues in the second quarter of 2023, profit share revenue represented $17.8 million, program fees were $17.9 million, and claims administration fees and others totaled $2.5 million. Now let's turn to profit share. As a reminder, 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. Profit share revenue in the second quarter of 2023 associated with new originations was $19 million or $553 per certified loan as compared to $26.3 million or $591 per certified loan in the second quarter of 2022. In the second quarter of 2023, we recorded a $1.2 million negative change in estimated future profit share related to business and historical vintages. Primarily due to higher than anticipated prepayments and default frequency, partially offset by lower than anticipated severity of losses in the near term. Concerning severity, the Mannheim Used Vehicle Value Index, the movie, experienced the worst May and June in the history of the index. Despite this significant decline, I will note that our conservative forecasting and modeling were in line with the movie as we exited the second quarter of 2023. As you may recall and for reference, In Q1 of 2023, we recorded a $700,000 positive change in estimate. Looking at this on a year-to-date basis, our profit share change in estimate was approximately $500,000 negative, a nominal impact on cumulative profit share revenue. Gross profit was $32 million and gross margin was approximately 84% in the second quarter of 2023 as compared to $47 million and gross margin of approximately 90% in the second quarter of 2022. Operating expenses were $16.3 million in the second quarter of 2023 compared to $14.2 million in the second quarter of 2022 as compared to $15.8 million in the first quarter of 2023. We continue to be prudent in adding incremental cost in the current environment. However, given the strength of our balance sheet, cash, and margin profile, we are making measured and controlled investments in our business to ensure we are well positioned for growth as market conditions improve. Operating income was $15.7 million in the second quarter of 2023 compared to $32.8 million in the second quarter of 2022. Net income for the second quarter of 2023 was $11.4 million compared to net income of $23.1 million in the second quarter of 2022. Basic and diluted earnings per share were $0.09 in the second quarter of 2023 as compared to $0.18 in the previous year quarter. Adjusted EBITDA for the second quarter of 2023 was $20.7 million as compared to $34 million in the second quarter of 2022. There's a reconciliation of GAAP to non-GAAP financial measures that can be found at the back of our earnings press release. We exited the quarter with $386.8 million in total assets, of which $224.4 million was in unrestricted cash, $59.7 million was in contract assets, and $63.3 million in net deferred tax assets. We had $167.7 million in total liabilities, of which $145.7 was outstanding debt. Year-to-date, we generated $42.6 million in cash before acquiring 21.3 million or 3.1 million shares of our common stock at an average price of $6.87 per share. Now moving to our Q3 guidance. We are encouraged that auto supply appears to have troughed. and absent a potential UAW strike, supply is expected to continue to improve. However, on the demand side, we are looking for signs of incremental improvements and have taken the following factors into consideration in our guidance. The impact of affordability on our target borrower due to elevated used car prices, inflation, and rising interest rates, near-term liquidity challenges for our credit unions, tightening underwriting standards leading to a shift towards prime and super prime borrowers, lenders exiting the indirect auto lending channel as a response to current market conditions, increased percentage of cash buyers due to the current interest rate environment, and continued Federal Reserve actions and potential impact on our refinance channel volumes. Accordingly, with these considerations, our guidance for the third quarter of 2023 is as follows. total certified loans to be between $26,000 and $30,000, total revenue to be between $29 million and $34 million, and adjusted EBITDA to be between $13 million and $17 million. In closing, we have a strong balance sheet, no near-term debt maturities, and generate significant cash flow, which provides us with the financial flexibility to thoughtfully invest in our business, as Keith outlined previously. Given these actions, we expect to capture the pent-up demand as the sector and macroeconomic conditions inevitably recover. We would like to thank everyone for joining us today, and we will now take your questions.