Enova International, Inc.

Good afternoon, and welcome to the Inova International Second Quarter 2022 Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your telephone keypad. To withdraw your question, please press star, then two. Please note, this event is being recorded. I would now like to turn the conference over to Lindsay Savarese, Investor Relations for Inova. Please go ahead.

Thank you, Operator, and good afternoon, everyone. Inova release results for the second quarter 2022 ended June 30th, 2022, this afternoon after the market closed. If you did not receive a copy of our earnings press release, you may obtain it from the Investor Relations section of our website at ir.inova.com. With me on today's call are David Fisher, Chief Executive Officer, and Steve Cunningham, Chief Financial Officer. This call is being webcast and will be archived on the investor relations section of our website. Before I turn the call over to David, I'd like to note that today's discussion will contain forward-looking statements and as such is subject to risks and uncertainties. Actual results may differ materially as a result from various important risk factors, including those discussed in our earnings press release and in our annual report on Form 10-K, quarterly reports on Forms 10-Q, and current reports on Forms 8-K. Please note that any forward-looking statements that are made on this call are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. In addition to U.S. GAAP reporting, Inova reports certain financial measures that do not conform to generally accepted accounting principles. We believe these non-GAAP measures enhance the understanding of our performance. Reconciliations between these GAAP and non-GAAP measures are included in the tables found in today's press release. As noted in our earnings release, we have posted supplemental financial information on the IR portion of our website. And with that, I'd like to turn the call over to David.

Good afternoon, everyone. Thanks for joining our call today. I will start with an overview of our second quarter results, and then we'll discuss our strategy and outlook for the remainder of 2022. After that, I'll turn the call over to Steve Cunningham, our CFO, who will discuss our financial results and outlook in more detail. In the second quarter, we once again delivered solid top and bottom line results driven by strong demand and stable credit across all of our products. Revenue in the second quarter increased 54% year over year and 6% sequentially to $408 million. Adjusted EBITDA was $102 million and adjusted EPS was $1.64. We are committed to producing sustainable and profitable growth and are pleased with our continued execution on this front. Despite some turbulence in the macroeconomic environment, including elevated inflation and recession concerns, our customer base remains stable with better than expected demand and continued strong credit performance. I know these results will come as a surprise to some, but the macro trends for our target customers remain positive. Non-prime customers are actually on pretty solid footing with strong wage growth, particularly at lower income levels and excess saving levels of $2 to $3 trillion in totals, according to Barker. More importantly, the labor market remains high. The latest data from the Bureau of Labor Statistics shows that there were more job openings than people seeking jobs for the first time ever. In addition, the unemployment rate remains historically low, and wages are growing. While real wage growth has been negative the last couple of months because of elevated inflation, it remains very positive over a six-month, one-year, and five-year period. At a more focused level, the electronic bank statement data we obtained shows a meaningful increase in our customers' monthly income over the past year. The electronic bank statement data also shows healthy spending as consumers still have savings accumulated during the COVID pandemic and appear to be trying to make up for lost time by increasing their spending in dining, travel, and clothing. Despite the higher savings in wages, many of our customers still live paycheck to paycheck and have temporary dislocations between their earnings and expenditures. As we've mentioned before, low unemployment plus inflation generally mean consumers may need loans for additional capital, but have earnings to pay those loans back. And as the results demonstrate, our customers continue to manage well through the current rise in inflation. Looking forward, while the economy could dip into a recession, and possibly already has, recessions tend to have less of an impact on our customers than on prime borrowers. They are experienced in living paycheck to paycheck and are able to quickly adjust their finances as needed. As for our S&V customers, the surge in consumer spending I mentioned is helping small businesses. And businesses have been able to pass along price increases, bolstering their bottom line and creating a strong credit environment. So while we feel very good about the performance of our customers in this current environment, we are cognizant of the fact that the economy could continue to deteriorate. As a result, we are taking a more balanced approach between growth and risk at the moment. while we always keep a sharp focus on credit. In late 2020, we began aggressively increasing our origination coming out of the pandemic, and by Q2 of 2021, our focus was to grow as fast as prudently possible given the strong demand we received, very strong credit metrics, and supportive macroeconomic environment. But beginning in late Q1 of this year, we shifted our focus to put credit performance on a more even plane with growth. As you can see from our origination growth in Q2, this does not mean we are retracting, but it does increase the resiliency of our portfolio. We do this by increasing our ROE targets across our products. In Q2, our ROE was more than double our weighted average cost per capita, showing that we have plenty of room for credit performance to deteriorate while still generating healthy returns. And finally, The high payment frequency and relatively short duration of our portfolio provides fast feedback that we incorporate into ongoing decision-making, enabling us to react quickly if the economic environment changes. The result is that credit quality remains strong, with net charge-offs of 7.2% in the second quarter compared to 7.6% in Q1. Notably, net charge-offs remained well below pre-COVID levels of 11.8% in Q2 of 2019 and 12.4% in Q2 of 2018. Total originations for the second quarter totaled just over $1 billion, up 5% sequentially from an unusually strong Q1, and up 60% compared to our second quarter of 2020, while our portfolio grew 68% nearly $2.4 billion. Our marketing efforts have been highly effective as originations from new customers were 42% of total originations. The strong new customer growth we have seen over the last several quarters provides a big tailwind as those customers return for additional credit over time. We're encouraged by this growth as returning customers with a successful history of paying performance typically default at a much lower rate than new customers. As we've discussed in depth, our highly diversified portfolio provides us additional protection against changes in the macroeconomic and regulatory environment and changes in the competitive environment. In the second quarter, small business products represented 57% of our portfolio, while consumer accounted for 43%. Within consumer, line of credit products represented 30% of our consumer portfolio, installment products accounted for 69%, and short-term loans are now only 1%. We continue to expect the mix between consumer and small business to fluctuate over time based on both macroeconomic factors and seasonality. We continue to see strength in small businesses that have been beneficiaries of the economy reopening as the pandemic raged. Due to small business originations were 3% higher than Q1, and credit performance in the portfolio remained strong. We do continue to analyze real-time cash flows as well as external data to monitor industries that are more prone to recession. And over the last several quarters, we have been pulling back on a few recession-prone industries like construction and transportation. As we have discussed previously, we have demonstrated a prudent approach to growing our small business growth. Looking further out, we believe we are competitively well-positioned given the strong brand presence and diversity of our portfolio. And the success of the ONDEC acquisition continues to exceed our expectations. We delivered on our divestiture strategy this year that we communicated at the time of the acquisition to monetize our investments in ODX, ONDEC Canada, and ONDEC Australia. These transactions will enable us to focus our resources on our core consumer and small business brands in the US and Brazil. In sum, we've been successful through a number of economic cycles, including the Great Recession and the onset of the COVID pandemic. Our success is a testament to the strength of our proprietary technology and analytics and our extremely talented employees. In addition, our diversified product offering provides additional resiliency and our portfolio is more diversified than ever. We continue to see solid momentum across Inova, with a very strong start to Q3 originations and continued stable credit. We will, as always, manage the business to drive profitable growth and believe that our highly flexible, online-only model, extensive track record of navigating different market conditions, strong balance sheet, and talented team will drive our performance in the years to come. Now I would like to turn the call over to Steve Cunningham, our CFO, who will discuss our financial results and outlook in more detail. And following Steve's remarks, we'll be happy to answer any questions that you may have. Steve?

Thank you, David, and good afternoon, everyone. As David noted in his remarks, we delivered another solid quarter of top and bottom line financial performance as our team leveraged our diversified product offerings, machine learning powered credit risk management capabilities, and effective marketing to drive meaningful growth while maintaining solid portfolio credit performance and attractive unit economics. Turning to our second quarter results, total company revenue for the second quarter rose 6% sequentially and increased 54% from the second quarter of 2021 to $408 million. The increase in revenue was driven by the continued growth of total company combined loan and finance receivables balances, which on an amortized basis were $2.4 billion at the end of the second quarter, up 10% sequentially and 68% higher than the second quarter of 2021. As David noted, total company originations for the second quarter totaled $1.1 billion, up 5% sequentially and 60% higher than originations during the second quarter of 2021. Originations from new customers remain strong, totaling 42% of total originations, as our marketing activities remain highly effective. Small business revenue increased 13% sequentially and 75% from the second quarter of the prior year to $150 million. Small business receivables on an amortized basis totaled $1.4 billion at June 30th, a 13% sequential increase and 75% higher than the end of the second quarter of 2021 as small business originations increased 70% from the prior year quarter to $679 million. Revenue from our consumer businesses increased 2% sequentially and 45% from the second quarter of 2021 to $253 million. Consumer receivables on an amortized basis ended the second quarter at $1 billion, up 6% from March 31st and 59% higher than the end of the second quarter of 2021, as consumer originations rose 74% from the prior year quarter to $410 million. Looking ahead, we expect the sequential growth rate and total company revenue for the third quarter to be slightly higher than the sequential growth rate for the second quarter. This expectation will depend upon the timing, speed, and mix of originations growth. As expected, the net revenue margin for the second quarter was 65%, as credit quality, which is the most significant driver of portfolio fair value, continues to perform in line with our expectations. The change in fair value line item included two main components, net charge-offs during the quarter, and changes to the portfolio's fair value resulting from updates to key valuation inputs, including future credit loss expectations, prepayment assumptions, and the discount rate. I'll discuss both items in more detail. First, the total company ratio of net charge-offs as a percentage of average combined loan and finance receivables the second quarter was 7.2%. Down from 7.6% last quarter, and up from 2.4% in the second quarter of 2021. The second quarter net charge-off ratio for small business receivables was 2.2%, up from 1.9% last quarter and 70 basis points in the second quarter of 2021, but below pre-pandemic periods as we continue to see strong payment performance across all of our small business products. The consumer net charge-off ratio for the second quarter declined to 13.7% from 14.2% last quarter and is higher than the 4.6% ratio in the prior year quarter, which preceded the acceleration of growth in consumer receivables over recent quarters, especially from new customers. The percentage of total portfolio receivables past due 30 days or more was 5.1% at June 30th. down from 5.2% at March 31st and lower than the 5.7% ratio at the end of the second quarter a year ago. A decrease in the consumer portfolio's 30-plus days delinquency ratio drove the sequential decline. As a result of solid credit performance and a stable outlook for the expected lifetime credit performance of our portfolio, The fair value of the consolidated portfolio as a percentage of principal at June 30th increased slightly from March 31st to just over 107%. As we've noted in our 10-K, the portfolio's fair value is most sensitive to changes in the expected lifetime credit performance of our receivables. Our analytics team forecasts expected lifetime credit loss expectations for our products Using estimation methods and machine learning powered models that have been the foundation of our ability to successfully manage credit risk over the life of our company. The cumulative lifetime credit loss estimate is a critical input for both our unit economics that drive decision making, as well as our initial fair value calculations for new vintages. For previously originated vintages, The cumulative lifetime loss estimate is updated each quarter in order to calculate the current fair value for the remaining receivables. These lifetime loss forecasts and related fair value estimates receive significant review and validation internally from senior management and our analytics, accounting, and model risk teams, and externally by our external auditors from Deloitte, who have built their own models to test the accuracy of our fair value calculations each quarter. As we've noted for several quarters, the credit performance of our portfolio has been in line or better than our expectations. This would lead to stability or improvement in the cumulative lifetime loss estimates for the portfolio using the aforementioned highly controlled estimation process. Stability or improvement in the cumulative lifetime loss estimates for the portfolio, all things being equal, would result in stability or improvement in the fair value premium as a percentage of principal. Even with $4.1 billion in originations over the past year and record levels of new customer originations, this quarter marks the third consecutive quarter that the fair value premium as a percentage of principal for both our consumer and small business products has increased as payment performance for both portfolios continues to be in line or better than our expectations. In addition to future credit loss expectations, every quarter we also evaluate discount rates and other key valuation assumptions used in our fair value models. As a result of this analysis for the second quarter, we increased discount rates used in the fair value calculations by 25 basis points for most of our products. to incorporate observed market information. To summarize, the change in fair value line item this quarter is driven primarily by improved levels of net charge-offs, slightly higher discount rates, and credit metrics and modeling at the end of the second quarter that continue to reflect a solid outlook for expected future credit performance for our growing portfolio. Looking ahead, we expect the net revenue margin for the third quarter of 2022 to be similar to the second quarter net revenue margin. Our future net revenue margin expectations will depend upon portfolio payment performance and the timing, speed, and mix of originations growth. Now turning to expenses, total operating expenses for the second quarter, including marketing, were $168 million, or 41% of revenue, compared to $129 million or 49% of revenue in the second quarter of 2021. Our operating expenses this quarter reflect increased marketing spend from solid customer demand that drove stronger than expected originations as well as continued scaling of our fixed costs. Marketing expenses totaled $92 million or 22% of revenue compared to $55 million or 21% of revenue in the second quarter of 2021. As a reminder, under fair value accounting, we recognize marketing expenses in the period they're incurred instead of deferring a portion and recognizing them over the life of the loans as we did prior to 2020 and as many in the industry still do today. Looking forward, we expect marketing expenses as the percentage of revenue to be in the low 20% range for the rest of the year, but will depend upon the growth and originations, especially from new customers. Operations and technology expenses for the second quarter totaled $42 million or 10% of revenue compared to $35 million or 13% of revenue in the second quarter of 2021. Given the significant variable component of this expense category, Sequential increases in ONT costs should be expected in an environment where originations and receivables are growing and should range between 10 and 11% of revenue. General and administrative expenses for the second quarter totaled $34 million, or 8% of revenue, compared to $39 million, or 15% of revenue, in the second quarter of 2021. While there may be slight variations from quarter to quarter, We expect G&A expenses as a percentage of revenue to remain below 10% as these expenses scale with growth through the remainder of 2022. We recognized adjusted earnings, a non-GAAP measure, of $55 million, or $1.64 per diluted share, compared to $1.67 per diluted share last quarter and $2.26 per diluted share in the second quarter of the prior year. We ended the second quarter with $232 million of cash in marketable securities, including $144 million in unrestricted cash, and had an additional $803 million of available capacity on $2 billion of committed facilities. As we announced earlier in the month, during June we increased our funding capacity by $550 million. we closed a new two-year $420 million small business securitization warehouse with two new bank lenders that is priced at 271 basis points over the applicable base index and will support funding small business customer demand. In addition, we increased the capacity of our existing secured revolving corporate credit facility, which is used for working capital and other general business purposes by $130 million to $440 million. The maturity of the facility was extended to June 2026 and is priced at SOFR plus 350 basis points. These new committed facilities further enhance our solid liquidity profile and financial flexibility, and the attractive terms reflect the solid credit performance of our portfolio and strength of our bank partnerships. Our cost of funds for the second quarter was 5.8%. versus 7.8% for the second quarter of 2021. Currently, our marginal cost of funds ranges from approximately 2% to 6%, depending on the facility utilized. Demonstrating our confidence in the continued strength of our business relative to our current valuation, during the second quarter, we acquired 743,000 shares at a cost of approximately $25 million. At June 30th, we had $47 million remaining under our $100 million share repurchase program. Our solid balance sheet and ample liquidity give us the financial flexibility to successfully navigate a range of operating environments and to continue to deliver on our commitments to long-term shareholder value through both continued investments in our business as well as share repurchases. To summarize our third quarter outlook, With continued strong customer demand and meaningful growth in originations and receivables, we expect revenue to increase sequentially at a slightly higher rate than the second quarter sequential rate. As we continue to see strength in both consumer and small business credit metrics across our portfolio, we expect the total company net revenue margin will be similar to the second quarter. In addition, we expect marketing expenses in the low 20% of revenue and continued scaling of our fixed costs with growth. These expectations should lead to adjusted EBITDA margins in the mid-20% range. We also expect quarterly year-over-year increases in adjusted EPS to resume in the third quarter of 2022. Our third quarter expectations will depend upon the timing, speed, and mix of originations growth. We remain confident that the demonstrated ability of our talented team has us well-positioned to adapt to the evolving macro environment. Our resilient direct online-only business model, diversified product offerings, nimble machine learning-powered credit risk management capabilities, and solid balance sheet support our ability to continue to drive profitable growth while also effectively managing risk. And with that, we'd be happy to take your questions. Operator?

We will now begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. Our first question is from David Scharf with JMP. Please go ahead.

Hey, good afternoon. Thanks for taking my question.

Sure.

Hey, you know what? I had the usual laundry list of generic questions on credit, which everybody seems to line up with these days. And you addressed a lot of them proactively. But, you know, maybe looking ahead, though, David, a couple things first. you know, I was curious about, and it's really sort of how, you know, what levers, you know, get pulled first, I guess, if, you know, we do see some deterioration in credit quality, whether it's from inflation, finally some loosening of the labor markets or whatnot. And can I start with the new customer concentration? You know, I can recall a few years ago, when the percentage of originations from new customers or new borrowers, I think it breached 30%, and that was kind of called out. It's sort of a milestone. Now it's north of 40. If you start to see any kind of stress on payment rates, is that usually sort of the first thing you pull back on, just the percentage of new borrowers you take on, or is that kind of too simplistic? Is it a much broader... sort of tightening of underwriting.

I mean, at a high level, that is correct. I mean, it obviously is much more complicated than that, so it is a bit simplistic. It doesn't mean we don't do anything on the existing customer side, but yeah, you tend to take more action with new customers because there is more risk there. And you do it by, I mean, there's two ways there's two ways of doing it, pulling back on marketing, especially your least efficient marketing, so at least the customers you're bringing on have higher ROE targets or higher expected ROE And then tightening on credit. We can do both. But I think it's important when you're comparing to a few years ago, yeah, when 30% new customers kind of was at the high end, is our mix has changed significantly. So net credit's a much bigger portion of the business. And with longer-term loans and SMBs are much bigger. part of the business also with longer loans where there's fewer refis. And I think most importantly, or just as importantly, single pay where there was a lot of refinances and rollovers where new customers became returning customers very quickly, that is a minuscule portion of our business now, sub 1%. So that's largely been replaced by line of credit business where you don't those customers stay as, you know, don't become repeat customers until they completely pay off their lines and take on a new line. So some of it is mixed, but we clearly have lots of levers to pull when we're seeing, and when we see credit deteriorate And we see it very quickly, right, because of high payment frequency across all of our, even our longer-term products. I mean, the average duration of those products is, you know, kind of at two years-ish on the near prime side. Everything else is below a year. So we have very high payment frequency and very short loans, so we can act very, very quickly.

Got it. Listen, you know, I certainly don't expect you to comment on specific things, competitors or other lenders. I mean, you know, during this reporting season, we are hearing about, in contrast to your experience, increasing delinquencies among subprime auto, some other subprime unsecured lenders. And, you know, just to make sure I kind of heard correctly, I mean, is there anything in the month of July, just as, you know, post Q2, just with respect to 30 more days of exorbitant gas prices? I mean, is there anything in the electronic bank data or otherwise that suggests any change in behavior among your customers?

Let me answer the second part first. Let me go back to some of the competitors. So, no. If anything, I would say things look a little better even in July. So, business is looking very, very good. You know, look, subprime auto, you just got to put it in a separate bucket. It's an entirely different business, driven by different factors, largely like the price of cars. I mean, we've seen over the years, there's almost no correlation between subprime auto lenders and unsecured near-prime, subprime lenders. But look, it's not all bad news. You know, there are, you know, kind of near-prime, prime lenders that have reported today that reported very good credit data. So, you know, a couple data points. where people struggle a little bit and some other data points where people, you know, are doing really, really well. So, you know, see how the rest of the reporting season goes. But, look, I mean, we look at the data in so many detailed ways, you know, 10 times levels deeper than we report publicly. And credit is looking great across our products right now.

Got it. Fair enough, man. Definitely. Last question, another one that's a little tough to answer with a perfect quantification, but as we think about the balance between the ROE you're currently delivering, particularly on the higher margin consumer loans versus SMB, versus buying back your stock at these levels, is there a certain... you know, multiple or just, you know, benchmark stock price where it just becomes a no-brainer to allocate more capital towards buying back the shares, even if you're seeing, you know, no deterioration in credit or marketing efficiencies?

Yeah, I mean, for sure. Yeah, I mean, for sure. I think at these levels, you know, we are excited to buy back our stock, and we have been. when the stock was at these levels. This time, a little later last year, we were really aggressively buying back our stock. The only thing that really holds us back from buying more is our bond covenants, which limit how much of our net income we can use each quarter to buy back our stock. We've been aggressive buyers of our stock and will continue to be at anything around these levels, near these levels, continue to be aggressive buyers of our SEC. Got it. With a billion dollars of liquidity, we don't have to make that choice. We can do both.

Right, right, right. I mean, obviously, 20-fold factor of borrowing capacity versus the authorization. Can you just remind me what the covenant caps?

Basically, 50% of net income is kind of the easy way to think about it.

Okay, got it. All right. Well, thank you.

Yeah, absolutely.

The next question is from John Hecht with Jefferies. Please go ahead.

Hey, guys. Congratulations. You're on a good quarter. I guess a little tag on Dave's question. You're looking at business versus business. Is there a difference between the small business side versus the consumer side, or are they pretty much more in the mix in that regard?

I mean, you broke up a little bit, John, but I think I got your question, like kind of capital allocation between small business and consumer. We love both businesses. We love being diversified, and again, with a billion-ish dollars of liquidity, we don't have to make a choice of capital allocation. We can grow both as fast as, you know, makes sense given our ROE targets. So, you know, the Treasury team has done a terrific job making sure our balance sheet is super strong so we're not having to make, you know, tough choices between two businesses that are doing really well right now.

I appreciate that. Actually, the question was, I apologize if I'm having a bad signal here, but the question was more tied to the mix of new versus recurring customers. Is it similar in both those segments?

Yeah, it's totally different by product, not even by segment. I mean, if you look at installment loans versus line of credit, some of that is just what we call new versus returning line of credit products versus installment products. But, you know, at a high level, subprime has the fewest number of new customers just because there's so many recurring. Near prime has the most just because they're longer term, they're longer loans. So you're not bringing back as many returning customers and small businesses in the middle.

Okay. And then... You guys have done a good job, obviously, really growing your originations this year without really sacrificing credit. Is there anything on the customer acquisition front, whether it's media, whatever channels of marketing or customer acquisition costs that are worth calling out to us?

No, I mean, we have, you know, I think, as you know, we really diversified our marketing channels as well, not only our products, but our marketing channels over the years. You know, they used to be very, very lead-focused historically. Then they became really direct mail-focused. And, you know, now we've really strengthened our capabilities both on TV and other broad-based media as well as digital. So, yeah. You know, they certainly fluctuate across products and fluctuate from quarter to quarter, but it is a pretty diversified marketing mix at this point. Okay.

Great. Thanks very much, guys.

Yep. Thank you.

Again, if you have a question, please press star then one. The next question is from John Rowan with Jannie. Please go ahead.

Good afternoon, guys.

Hey, John. Hey, John.

So I think the guidance, if I correct me if I'm wrong, was that year-over-year EPS growth will resume in the second quarter, correct?

That's right.

Does that apply for the fourth quarter as well, or is that just second quarter?

Third quarter, I think you mean, right? Third quarter, guys?

Yeah. I'm sorry. It was just the third quarter. That's not the fourth quarter, correct?

That's correct.

Okay. Obviously, this quarter was the first quarter where we've seen the gross profit margin in line with the long-term guidance of 55% to 65%. Is that still a good range? I just want to make sure there's no update to that range.

Yeah, John, I think that's still the right range. I mean, if you look across the different products, just given what we've done with consumer, it's a little, it's a touch below like our more normal range, but we've also seen strong growth and a high mix of new customers, as David mentioned. And small business credit has really continued to drive a high net revenue margin for small business, which I would expect to settle in somewhere between the low 60s to low 70s. So I still think the 55 to 65 is a good range. And as we continue to move forward, if we're in a more normalized environment, you'll see those two product segments settle in at their more normal ranges.

Okay. Thank you very much.

Yeah, thanks, John. This concludes our question and answer session. I would like to turn the conference back over to David Fisher for any closing remarks.

Thanks, everyone, for joining our call today, and we look forward to speaking with you again next quarter. Have a good evening.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.