Enova International, Inc.

Good afternoon and welcome to the ENOVA International Second Quarter 2023 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 released results for the second quarter, 2023, and in June 30, 2023, this afternoon after 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, Innova 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.

Thanks. Good afternoon, everyone. I appreciate you joining our call today. I'll start with an overview of our second quarter results, and then I'll discuss our strategy and outlook for the remainder of 2023. After that, I'll turn the call over to Steve Cunningham, our CFO. We'll discuss our financial results and outlook in more detail. In the second quarter, we were once again able to deliver strong top and bottom line numbers. Our consistent performance is the result of our talented team executing on our balanced approach to growth by leveraging our world-class machine learning algorithms and technology across our diversified product offerings, enabling us to quickly adapt to the current macroeconomic backdrop. The result was Innova originating more than $1 billion for the seventh quarter in a row, Additionally, we're pleased to see solid credit quality across all of our businesses. Revenue in the second quarter was just shy of half a billion dollars, which is a 22% increase year over year and 3% sequentially, demonstrating our ability to generate strong growth in an uncertain market environment. As a result of strong revenue growth and diligent credit management, adjusted EBITDA and adjusted EPS increased 24% and 5% year-over-year to $126 million and $1.72 respectively. In line with our expectations and typical seasonality for our business, adjusted EBITDA was flat compared to Q1 of this year and adjusted EPS was down 4% sequentially. Given the continued uncertainty in the macroeconomic environment, We are maintaining the higher than typical ROE targets across our products as we've discussed in prior quarters. That being said, strong demand, especially on the consumer side of our business, combined with continued solid credit performance, enabled us to be more aggressive with originations. Our combined loan and finance receivables increased 20% year over year to $2.9 billion, driven by a 2% year over year increase and 5% sequential increase in originations. Strong demand and our balanced approach to growth contributed to efficient marketing in the quarter as it decreased to 19% of our total revenue from 22% in Q2 of last year. So much of the past few quarters, our diversified portfolio continues to drive our growth. While business products represented 62% of our total portfolio, up from 57% in Q2 of last year. SMB revenue increased 27% year-over-year and was down 2% sequentially as we continued to maintain good credit and hit our unit economic targets. Under Q1 call, we discussed that in general, not all of our products move in lockstep. there may be quarters where we tighten our underwriting in either our consumer or SMB business to bring our results in line with ROE targets. As a result of our conscious decision to raise our unit economic targets and our proven ability to manage our portfolio, we continue to generate strong unit economics in our SMB portfolio as we have targeted those higher ROE and unit economic targets. As Steve will discuss in more detail, We are pleased to have recently raised more than $500 million of funding to support our SMB business and our receivables growth, reinforcing the strength of our performance of that portfolio. Turning to our consumer business, which performed exceptionally well in Q2, consumer revenue increased 19% year-over-year and 8% sequentially, driven by strong demand for our consumer line of credit products. Credit metrics are very strong across our portfolio, evidenced by the fact that our consumer net charge-off rate declined to the lowest levels we've seen in the past several years. This is to be expected given our focus on prudent underwriting coupled with all the positive consumer economic data. Job growth remains strong, wages are continuing to rise, and inflation is easing. In line with our expectations, and consistent with the prior few quarters, the percentage of consumer installment loans in our portfolio decreased in Q2, while our line of credit products increased as a percent of total consumer loans. As a reminder, we have continued to de-emphasize our longer-term near prime installment loans and are instead focusing on our shorter duration and smaller dollar consumer line of credit products, giving us a more real-time view into credit performance given the higher payment frequency and relatively short duration. Turning to credit performance, overall credit was strong in the quarter as we continued to successfully manage credit through the current macroeconomic environment, leading to continued solid profitability. Net charge-offs were 7.6% in the second quarter, down from 8.2% last quarter. Notably, net charge-offs remained well below pre-COVID levels of 11.8% in Q2 of 2019 and 15.9% in Q2 of 2018. In sum, our stable, strong results continue to prove time and time again that we are skillful operators in a variety of environments. Our flexible online-only business model nimble machine learning powered credit risk management capabilities, diversified product offerings, and solid balance sheet position us well to continue to drive profitable growth while also effectively managing risk. Our sophisticated technology and analytics are primed to quickly adapt to any changes in the economic environment, which combined with our vast experience puts us in a unique competitive position to take market share in a nine prime lending landscape. To wrap up, as Steve will discuss in more detail, we've been very thoughtful about building a strong balance sheet and ended the quarter with $1.1 billion of total liquidity. This gives us the flexibility to continue to deliver on our commitment to driving long-term value for our shareholders. We have demonstrated our ability to drive consistently strong results in a variety of macroeconomic environments. Yet we continue to believe there's still a disconnect between our business fundamentals and our current valuation. As such, we will continue to work with external advisors to gauge various alternatives. While we are exploring all options to further unlock shareholder value and are not set on any one plan yet, We remain committed to repurchasing shares and bonds and are confident that there's more that can be done. With that, I would like to turn the call over to Steve, who will discuss our financial results and outlook in more detail. And following Steve's remarks, we will be happy to answer any questions that you may have. Steve?

Thank you, David, and good afternoon, everyone. We're pleased to report another solid quarter of top and bottom line financial results that are in line with or better than our expectations. as we continue to consistently deliver differentiated financial performance. Over the past four years, we've meaningfully diversified and de-risked our business, navigated significant macroeconomic schemes, and absorbed a rapid rise in market interest rates while maintaining strong profit margins. Through the first half of 2023, compared to the same period during 2019, we nearly doubled our revenue, and reduced our net charge-off rate by almost half while delivering a solid after-tax adjusted earnings margin of 11.6%. This is a testament to our experienced team's ability to consistently deliver strong shareholder value by leveraging our flexible online-only business model, diversified product offerings, world-class machine learning risk management algorithms, and our strong balance sheet. Turning to our second quarter results, Total company revenue increased 22% from the second quarter of 2022 to $499 million. The year-over-year increase in revenue is driven by the growth of total company combined loan and finance receivables balances, which on an amortized basis increased 20% from the end of the second quarter of 2022 to $2.9 billion at June 30th, as total company originations this quarter rose to $1.1 billion. Small business revenue increased 27% from the second quarter of 2022 to $190 million as small business receivables on an amortized basis, ended the quarter at $1.8 billion, 30% higher than the end of the second quarter of last year. Small business originations of $712 million increased 5% from the second quarter a year ago. Revenue from our consumer businesses increased 19% in the second quarter of 2022 to $302 million as consumer receivables on an amortized basis, ended the quarter at $1.1 billion, or 7% higher than the end of the second quarter of 2022. As David mentioned, with the strong consumer demand and credit performance we're seeing, we're moderately more aggressive with consumer originations this quarter, which grew 38% sequentially to $401 million. Demand for our consumer line of credit products remains strong as originations for these products comprise 73% of total quarter consumer originations and grew 42% sequentially, 74% from the second quarter of 2022. Looking ahead to the third quarter, we expect total company revenue to grow between 5% and 10% sequentially, depending upon the level, timing, and mix of originations growth during the quarter. Now turning to credit, the net revenue margin for the second quarter of 60% was in line with our expectations. Credit quality, which is the most significant driver of net revenue and portfolio fair value, remained solid. Credit metrics for the total company continue to reflect our balanced approach to growth in this macroeconomic environment. Strong consumer credit performance, and the ongoing seasoning and normalization of our small business portfolio. The total company ratio of net charge-offs as a percentage of average combined loan and finance receivables for the second quarter, 7.6%, compared to 8.2% last quarter, as the consumer quarterly net charge-off ratio declined to the lowest non-pandemic level we've seen since 2017. The percentage of total portfolio receivables past due 30 days or more was 7.7% at June 30th, compared to 7.1% at March 31st, driven by the continued seasoning of recent large quarterly vintages in our small business portfolio, which was partially offset by improvement in the delinquency rate for our consumer portfolio. As we've previously noted, and as we've seen over the past year, In this macroeconomic environment, we expect there could be some quarter-to-quarter variability in credit metrics and that revenue margin in the near term for our consumer and small business portfolios. This may include temporarily falling above or below typical ranges as our portfolios season, as credit metrics move off of the unsustainably low levels that we experienced last year, and as we actively manage credit in our balanced approach to growth. With this expectation, as David noted, we increased ROE targets across our portfolios last year to ensure we have additional cushion in the profitability profile of our loans to protect against potential credit variability in market environments like we're in now. Similar to the consumer portfolio net revenue margin last year, the small business net revenue margin this quarter of 57% is just below our target of 60 to 70%. As recent vintages season, and credit metrics move off of the unsustainably low levels that we experienced last year. As we've previously discussed, we actively manage small business credit in our balanced approach to growth and would expect and have no concerns about credit metrics moving slightly above or below our targets for a short period of time. The lifetime credit loss outlook for our small business portfolio continues to reflect stability at the end of the second quarter with a fair value premium as a percentage of principal of 109%, remaining consistent with levels reported over the past year. As David mentioned, and as I'll discuss in more detail in a moment, strong fundamentals of our small business portfolio are also reflected in our ability to raise more than $500 million of cost-effective funding in recent months through funding partners and the capital markets to support small business receivables growth. Turning to consumer credit, our consumer net revenue margin of 62% this quarter reflects the continued strong performance of our consumer products, including some of the best credit metrics and fair value premiums that we've ever seen. As a result of the aforementioned trends in our small business and consumer portfolios, the fair value of the consolidated portfolio as a percentage of principal increased a percentage point sequentially. to 112% at the end of the second quarter. Looking ahead, with overall credit performance remaining relatively stable, we expect the total company net revenue margin for the third quarter of 2023 to be steady at around 60%. Future net revenue margin expectation will depend upon portfolio payment performance and the level, timing, and mix of originations growth. Now turning to expenses, Our operating costs this quarter reflect efficient marketing activities, continued leverage inherent in our online-only model, and thoughtful expense management. Total operating expenses for the second quarter, including marketing, were $179 million, or 36% of revenue, compared to $168 million, or 41% of revenue, in the second quarter of 2022. With the acceleration in consumer originations, Our marketing spend for the second quarter increased to $96 million, or 19% of revenue, compared to $92 million, or 22% of revenue, in the second quarter of 2022. We expect marketing expenses as a percentage of revenue to range from the high teens to low 20% in the near term, but will depend upon the growth and mix of originations. With growth in receivables and originations over the past year, operations and technology expenses for the second quarter increased to $47 million or 9% of revenue compared to $42 million or 10% of revenue in the second quarter of 2022. 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 It should range between 9 and 10% of total revenue. Fixed costs continue to reflect our focus on operating efficiency and thoughtful expense management. General and administrative expenses for the second quarter increased to $36 million, or 7% of revenue, from $34 million, or 8% of revenue, in the second quarter of 2022. While there may be slight variations from quarter to quarter, We expect G&A expenses as a percentage of total revenue of between 7 and 8% in the near term. Our effective tax rate was 25.7% in the second quarter compared to 24.9% in the second quarter of 2022. We expect our effective tax rate to remain around 25%. Our solid balance sheet and ample liquidity give us the financial flexibility to successfully navigate a range of operating environments, and has allowed us to deliver on our commitment to driving long-term shareholder value through continued investments in our business, as well as share repurchases and open market repurchases and retirement of our senior notes. We ended the second quarter with $1.1 billion of liquidity, including $272 million of cash in marketable securities and and $840 million of available capacity on facilities. We continued to successfully access new cost-effective funding to support our growth and financial flexibility. During the quarter, we closed our first-ever facility secured exclusively by small business lines of credit. Two-year, $287 million secured warehouse was priced at SOFR plus 420 basis points. Additionally, last week, we reentered the term securitization market with our first on-deck deal since 2021. The rated three-year fixed rate $227 million term transaction priced with a blended coupon of 7.7%. Demonstrating our confidence in the continued strength of our business relative to our current valuations. During the second quarter, we acquired 611,000 shares at a cost of approximately $28 million. And at June 30th, we had $114 million remaining under our authorized share repurchase program. During the quarter, we also opportunistically purchased an additional $26 million of our 2024 senior and secured notes in the open market at a slight discount to par. We had $180 million remaining of the 2024 senior notes at June 30th. Our cost of funds for the second quarter was 8.2%, or 240 basis points higher than the second quarter of 2022, primarily due to the increases in SOFR over the same time period. We expect our cost of funds to remain at a similar level for the remainder of this year, but will depend primarily upon changes in SOFR. And finally, we continue to deliver strong profitability this quarter with adjusted earnings, a non-GAAP measure of $55 million. And adjusted EPS grew 5% from the second quarter of 2022 to $1.72 per diluted share. To wrap up, let me summarize our third quarter expectations. We expect revenue to increase 5% to 10% sequentially as we continue to focus on an origination strategy that balances growth and risk against the current macro environments. This should lead to continued stable credit, resulting in a total company net revenue margin of around 60%. In addition, we expect marketing expenses as a percentage of revenue to range from the high teens to the low 20%, O&T costs to range between 9% and 10% of revenue, and G&A costs to range between 7% and 8% of revenue. These expectations should lead to sequential adjusted EPS growth that is faster than revenue growth. Our third quarter expectations will depend upon customer payment rates and the level timing and mix of originations growth. Barring a material change in the macroeconomic environment for the remainder of this year, we expect originations for the full year 2023 to grow around 10% compared to 2022 as we maintain our focus on an origination strategy that balances growth and risk, resulting growth in receivables, with stable credit and continued operating leverage, should result in full-year 2023 growth in both revenue and adjusted EPS compared to 2022 in excess of our expected originations growth rate. Given the strong demand we're seeing across products, combined with our stable credit performance, we certainly could grow originations faster. However, as we've discussed, we think having a more balanced approach to growth and risk makes sense in the current environment. Our expectations for the remainder of this year will depend upon the macroeconomic environment and the resulting impact on demand, customer payment rates, and the level, timing, and mix of originations growth. This quarter, we continue to demonstrate our ability to deliver strong financial results and that our balanced approach to growth is working. We remain confident that we are well positioned to quickly adapt to the evolving risks and opportunities in this macroeconomic environment. 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.

Good afternoon, and thanks for taking my questions. Hey, David, Steve as well, I was curious to get a little more color on your thoughts on consumer origination approach going forward, and specifically You know, given all of the positives you've highlighted, you know, strong employment for a lot of the verticals in particular that employ your borrowers, inflation's easing, a lot of these borrowers have probably been adjusting to that for months. Can you talk about maybe what incrementally you are monitoring or would like to see to expand beyond, you know, I guess your phrase, you know, moderately aggressive, you know, origination growth last quarter you know what what else is out there in your mind that's sort of casting a pall of uncertainty that maybe keeps you you know a little more restrained than you could be yeah i just think the overall risk in the economy and the recession risk going forward and you know i think we like others aren't seeing anything particularly troubling right now but um

you know, we've never seen an economic environment quite like this. And with the Fed's aggressive stance, you know, could it tip the other way and be a harder landing than people expect? I think that's kind of what we're looking out for. And as we've talked about historically, we're doing that by setting higher ROE targets than we have historically. But as I've also mentioned, the last two quarters, we're also leaning into growth on the consumer side and have gotten more aggressive. And I think, you know, our approach going into And the Q3 is to stay reasonably aggressive and probably even a bit more aggressive. And kind of within our current ROE targets, but increase marketing spend a bit. Shouldn't move the needle too much as a percentage of revenue because the growth should come along with it. But trying to increase the top of funnel is probably our biggest focus right now on the consumer side, given all the positive metrics we're seeing.

Got it, got it. Hey, and just as a follow-up, you know, shifting to SMB, you know, it looks like, you know, relative to last quarter, you know, I think you had talked about a 10% to 15% range, you know, for total origination and revenue growth. For the year, now it's modulated to greater than 10%. Is the slight trimming of that outlook, all SMB-related, and if so, is there anything different? I mean, directionally, it seems like credit and everything else is performing as well as consumer, but it does look like you pulled back a bit this second quarter. Is there anything either competitively, cost of funds, or anything that makes you a little less aggressive than on the consumer side?

I just think given the larger loans and the slightly longer term in the SMB side versus consumer, we just want to be a bit more cautious with that portfolio. There's plenty of demand credit metrics, as we talked about in Q1, were a tad worse than we had thought they were going to be. But we've since normalized that, and they were much better in Q2. So we could be more aggressive, for sure. There's plenty of demand within our ROE targets on the SMB side. We're just not convinced the risk-reward is there right now, again, given the uncertainty in the economy. An extra few percentages of origination growth for us this year is pretty inconsequential. We're still growing at a significant premium to our PE. you know, the risk reward of trying to eke out, you know, another $50 million of S&B growth in the back half of the year just doesn't seem worth the payoff at this time. But that's really it. I mean, that's just, you know, us trying to be smart operators, having a lot of experience doing that, and really not any concerns with the portfolio or demand at all. We're turning away plenty of good demand and, you know, the credit metrics are improving every month. So, again, just trying to be smart, cautious operators.

Great. Understood. Thanks so much.

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. Just to make sure I understood, so sequential revenue growth you're saying is 5% to 10%, correct?

That's right.

Okay. Did you guys book any gains in the quarter for buying back bonds if they were below par value? I know that was something we discussed last quarter.

We do not.

Okay. And then as far as share repurchases go – You know, obviously you said $114 million was remaining on the authorization, correct?

That's right.

Is that something you think you'd be dedicated to after that $114 million is exhausted? And just remind me what the repurchases were in a dollar term for the 2Q?

Yeah, we were just under $30 million for the quarter, for second quarter. And if you just, yeah, and the 114 is just the authorization that runs through the end of this year. If you just go back, John, over the past six years, our board has regularly reauthorized us to buy back. And as David mentioned in his remarks, capital returns we view as a very good opportunity to return capital to our shareholders as part of our focus on valuation. you should definitely not view the 114 as a constraint or a time bound on our capital return strategies.

All right. Thank you very much.

The next question is from Vincent Cantik with Stevens. Please go ahead.

Good afternoon. Thanks for taking my questions. First one, just wanted to talk about what you're seeing with the competitive landscape. We're hearing many companies talking about tightening. Just wondering if you're if you're seeing that and if you're seeing potentially any benefits as a result of others tightening. Thank you.

Yeah, we've been talking about a fairly weak competitive landscape probably for the last two, three quarters, and we've seen no signs of that changing. A bit surprisingly, actually, but consumer demand was very, very strong, and, you know, It's not a perfect science, what's competitive and what's market, but through some of our channels, we get good insights into the competitive dynamic. And we've seen no major signs of increase and even some tightening over the last quarter. And same with S&B. I think there's been no real new investment in that space with, well, at the same time, a couple of competitors increasing. exiting over the last couple of years. So, you know, we've, you know, in either of our businesses haven't seen any signs of the competitive environment increasing. And if anything, maybe even continuing to weaken a bit.

Okay. That's very helpful. And when you talked earlier about increasing the ROE hurdles on the products you're offering, is there, would you be able to frame how much higher sort of what, what degree you've tightened or increased your returns on your new originations.

Yeah. Like, you know, kind of, you know, 15 ish, 10 to 15% ish increases. We're certainly not, you know, you know, doubling, doubling our targets, but you know, 10 to 15, maybe 20% higher depending, um, on the products. And like we've talked about, we really did that kind of in Q4, sorry, in Q4 and Q1. So that's not something that's new that we expect to constrain volumes in the back half of the year.

Okay, perfect. And last one for me, you talked about continuing to unlock value and exploring ways to do that. It's nice to see the Sherry purchases and getting a lot of great value from that. Any additional thoughts that you have that you're willing to share about unlocking value? Thank you.

Yeah, I mean, there's some, like, as we've been mentioning, we've been talking to advisors about opportunities, and we think there's some out there just in this market environment with higher interest rates, you know, businesses, some businesses struggling in various stages. I don't think it's a perfect time to execute on those, but, you know, if we've seen, if we see, you know, other businesses weaken further that create bigger opportunities or as rates come back down, We think there might be additional ones, you know, whether it's in the back half of this year or into 2024. But, you know, if not, then there's not. We're willing to be very, very patient. We'll continue, as Steve just mentioned, to focus on other repurchases. And, you know, we still have plenty of capital. We're not capital constrained at all. So if bigger opportunities come around, you know, we'll continue to look and be prepared to execute on them.

Very helpful. Thanks very much. The next question is from Alexandra Villalobos with Jefferies.

Please go ahead. Good afternoon, and thank you for taking my question as well. A lot of my other questions were answered, but I did want to ask about the change in fair value marks for the quarter, just kind of a little bit more detail on kind of what happened versus prior quarter. Yeah, that's it.

Hey, Alex. Thanks for the question. So first of all, I'll start with SMB. And SMB has been very steady on a fair value premium basis for the past four or five quarters, which is an indication of just how steady our lifetime credit loss outlook is for that business. So performing, as we talked about, in line with our expectations. Consumer has performed very well. And there was a slight uptick in the fair value premium this quarter after some uptick last quarter as well. And that's basically reflecting credit continues to perform better than our expectations. And again, we have some pretty high return thresholds in our unit economics and the business continues to perform. And when that happens, the value of the portfolio will increase. So There's a bit of a move lower on our lifetime loss expectation on the consumer portfolio, and that's being reflected in some of the slight uptick in fair value this quarter. And that's really, the consumer side is really what's driving the overall company at this point with the stability in SMB.

Okay, perfect. Thank you so much. You bet.

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 us today. We appreciate your time and look forward to speaking with you again next quarter. Have a great evening.

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