OppFi Inc.

Good afternoon and welcome to OPFI's second quarter 2022 earnings call. All participants are in a listen-only mode. As a reminder, this conference call is being recorded. After management's presentation, there will be a question and answer session. It is now my pleasure to introduce your host, Sean Smolarz, Head of Investor Relations. You may begin.

Thank you, Operator. Good afternoon. On today's call are Todd Schwartz, Chief Executive Officer and Executive Chairman, and Pam Johnson, Chief Financial Officer. Our second quarter 2022 earnings press release and supplemental presentation can be found at investors.opfi.com. During this call, OpFi will discuss certain forward-looking information, These forward-looking statements are based on assumptions and assessments made by OPFI's management in light of their experience and assessment of historical trends, current conditions, expected future developments, and other factors they believe to be appropriate. Any forward-looking statements made during this call are made as of today, and OPFIGHT undertakes no duty to update or revise any such statement, whether as a result of new information, future events, or otherwise. Important factors that could cause actual results, developments, and business decisions to differ materially from forward-looking statements are described in the company's filings with the Securities and Exchange Commission, including the sections entitled Risk Factors. In today's Remarks by Management, the company will discuss non-GAAP financial metrics. A reconciliation of these non-GAAP financial measures to the most comparable GAAP measures can be found in the earnings press release issued earlier today. This call is being webcast live and will be available for replay on our website. I would now like to turn the call over to Todd.

Thanks, Sean, and good afternoon, everyone. I'd like to cover three topics today. including the key financial and operational highlights from our solid second quarter, our view on the macroeconomic environment and its impact on our customers, and provide a quick update on strategic initiatives underway that are designed to position us for success in 2023 and beyond. We are pleased with our financial and operational performance for the second quarter relative to our expectations. Continued strong customer demand led to a 57% year-over-year increase in originations. Marketing costs per funded loan dropped by 16% year-over-year to $206. The auto approval rate increased by 12 percentage points year-over-year to 62%. We reduced our operating expenses, excluding interest expense, add-backs, and one-time items, as a percentage of total revenue by three percentage points, as a direct result of initiatives we launched in the first half of the year. We also upsized one of our credit facilities, resulting in over 600 million of current funding capacity, and maintained a customer NPS score above 80 points. With regards to the macroeconomic environment, it is clear to us that the 40-year high inflation is having a negative impact on our customers. Our average customer is employed, college educated, earns middle household income, and has minimal savings. The increased price of everyday necessities like gasoline, groceries, and home utilities has crunched these customers and their ability to service debt, despite the strong labor market. We originally expected that inflation would be transitory, in line with previous economists' predictions. However, as we can see now, inflation has persisted well beyond our expectation. In early May, we started to see the effects of inflation on credit performance, both in new loans as well as older vintage refinance loans that were originated during last year's growth phase. In response, credit models were swiftly adjusted in May and again in July to target higher performing customers as inflation began accelerating. These measures represent the most significant credit adjustments in our company's history. As a result, the credit profile of new loans being funded through our platform has improved greatly since implementing these changes. We are encouraged to see continued strong demand for our product amongst these higher quality borrowers. Going forward, we will continue to diligently monitor macroeconomic changes and their impact on our customers and take action accordingly. Even with these credit tightening measures, our profitability in the second half of this year will be impacted by the delinquencies and charge-offs of loans originated with the previous credit model in the first half of this year. As a reminder, loans that charge off in a given quarter are generally originated in the prior two quarters. We now believe these loans from previous credit model will charge off at higher rates than initially expected. resulting in break even on an adjusted basis or a modest adjusted net loss for the full year. Despite our disappointment about the second half, we are confident that the lower risk receivables base we anticipate at the end of 2022 will perform very well in 2023. In addition to the credit measures I've described, we're taking additional measures in marketing and operations that we expect will further position us for success in 2023 and beyond. Shifting to our marketing efficiency initiatives, we believe there are significant opportunities to continue lowering our cost per newly funded loan. We are optimizing our partner channels by removing higher cost, lower quality partners and expanding higher quality ones. We have also taken steps to improve efficiency in direct mail and have seen significant reductions in cost per funded loan in this channel in Q2. Within operations, we have implemented a number of enhancements to reduce delinquency and promote payments by redesigning our customer portal with more capabilities and payment options. In addition, during the second half of this year, we are initiating new partnership models to provide financial health resources to our customers, as well as testing new programs to help customers make affordable payments, avoid charge-offs, and minimize adverse credit score impacts. Before I close my prepared remarks, I want to also highlight, as previously disclosed, that my family and I purchased $1.9 million of Class A common stock at an average price of $3.13 during the most recent open trading window. We are prepared to continue supporting OpFi shares when we see that the share price is disconnected from long-term fundamentals. While we are facing credit headwinds and the effects of the macroeconomic environment, We view these challenges as temporary speed bumps that we are able to navigate. We are confident that the actions we are taking will improve our performance in 2023 and make the company stronger than ever. With that, I'll turn the call over to Pam to review our second quarter results and updated guidance.

Thanks, Todd, and good afternoon, everyone. Turning now to our second quarter results. Total revenue increased 38% year-over-year to $108 million. We achieved a 57% year-over-year increase in originations to $226 million, while lowering our marketing costs per new funded loan by 16%, or $39 to $206, compared to the prior year period. Origination growth was driven by increased demand, resulting in higher application volume and an increase in the funded rate, defined as funded loans over qualified apps. Our more efficient marketing results reflect continued strategic growth in lower-cost marketing channels, such as email, referrals, and search engine optimization, as well as lower and more efficient spending on direct mail and higher customer conversion rates. Total net originations of new loans as a percentage of total loans increased 56%, up over 14 percentage points from the second quarter of last year. In addition, our investments in automation resulted in the auto approval rate increasing 12 percentage points year-over-year to 62%. The annualized net charge-off rate as a percentage of average receivables was 51% for the second quarter of 2022 versus 56% for the first quarter of 2022 and 28% for the prior year quarter. The year-over-year increase reflects credit trends worse than pre-pandemic levels. Turning to expenses, operating expenses for the second quarter, excluding interest expense as well as add-backs and one-time items, increased 30% to $49 million, or 45% of total revenue, from $38 million, or 48% of total revenue in the prior year period. These expenses increased due primarily to higher marketing costs to fund originations, more investments in technology, and greater professional fees. While the amount of expenses increased, expenses declined as a percentage of our total revenue as a result of lower marketing costs per new funded loan, as well as operational cost efficiency initiatives implemented earlier this year. Adjusted EBITDA totaled $20 million for the quarter, down from $32 million versus the prior year quarter, as higher revenues were more than offset by elevated charge-offs and increased operating expenses. As expected, our adjusted EBITDA margin compressed to 19% compared to 41% in the year-ago period. Interest expense for the second quarter totaled $8 million, or 7% of total revenue, compared to $6 million, or 8% of total revenue in the year-ago period. We generated adjusted net income of $7 million for the second quarter, compared to $18 million for the comparable period last year. As of June 30, 2022, OPFI had 84.3 million weighted average diluted shares outstanding, excluding 25.5 million earn-out shares. Adjusted earnings for the second quarter were $0.08 per share. Our balance sheet remains healthy with cash, cash equivalents, and restricted cash of $58 million, total debt of $337 million, gross receivables of $402 million, and equity of $166 million. We have ample liquidity available to support our future growth plans with $608 million in total funding capacity. In June, we announced that we more than doubled one of our credit facilities with Adelia to $200 million from $75 million. We utilized part of this upsizing to refinance debt tied to one of our other credit facilities. During the second quarter, we repurchased approximately 330,000 shares of Class A common stock for $1.1 million and an average of $3.31 per share. During the first half of 2022, we repurchased approximately 616,000 shares and an average $3.48 per share for a total of $2.1 million. Turning to our full-year outlook, given limited visibility and uncertainty considering the current macroeconomic environment, we are reiterating total revenue guidance of 20% to 25% growth year-over-year, maintaining guidance for operating expenses as a percentage of total revenue of 43% to 47%, excluding interest expense, add-backs, and one-time items, and a revising adjusted net income expectations downward. We now expect to break even on an adjusted basis or report a modest adjusted net loss for the full year due to persistent high inflation that caused significant credit deterioration in the latter half of the second quarter and early third quarter. We anticipate the net charge-off rate to increase in the third and fourth quarters as older vintage loans are charged off during those periods. While we anticipate having a more specific update for our full year expectations when we report third quarter results, for now we are withdrawing our previously issued guidance for metrics, other than the total revenue growth and operating expenses as a percentage of total revenue. Notwithstanding this revised outlook for 2022, we remain very optimistic about 2023. We expect to exit 2022 with a healthy portfolio, given the significantly tightened credit model and runoff of the higher risk loans from the first half of this year. With that, we would now like to turn the call over to the operator for Q&A. Operator?

Thank you. Ladies and gentlemen, the floor is now open for questions. If you do have a question, please press star 1 on your telephone keypad at this time. If you're using a speakerphone, we ask that while posing your question, you pick up your handset to provide favorable sound quality. Once again, ladies and gentlemen, if you do have a question or comment, please press star 1 on your telephone keypad at this time. Please hold as we poll for questions. And our first question comes from David Scharf from JMP Security. Please go ahead, David.

Great. Thank you. Hi, Todd and Pam. Thanks for taking my questions. Hey, not surprisingly, wanted to follow up on the commentary regarding the credit outlook and macro trends and First off, I'm wondering, Todd, kind of the tail end of a reporting season in which we've heard a pretty broad spectrum of commentary from a lot of different subprime lenders about the impacts of inflation and other factors. Some have been sort of pretty benign. Others less so. Your commentary is probably among the most pronounced and definitive. At this point, are you confident that it's strictly inflationary pressures, or do you think there are potentially other factors that are impacting consumer payment patterns?

Thanks, David. That's a good question. You know, I think if you look at last year, you know, we had thought that we'd gotten through most of the, I had mentioned that on the first quarter call, some of the originations we had made in the holiday season that were a little higher risk with different channel partners. You know, as those flow through the buckets, we have a forecast and we haircutted that forecast significantly at the beginning of the year. But when you have an existing book of business that's on your books deteriorate in a very quick period of time, it all happened pretty much around the May timeframe in a three-week period where we saw significant deterioration quickly. It then subsided and has stayed pretty stable. But we're being very conservative. you know, in our forecast, we've tightened significantly, you know, and obviously, that's going to sacrifice profitability this year, but we're not playing for a quarter or two quarters, you know, we're playing to build the best business we can over the long term. So anything we're doing now that may have short sighted impact on the adjusted net income is going to is going to help us in 2023, by having higher quality receivables. And, you know, we're also Pam and I talked about it. Our acquisition cost and growth is there. So we have the growth and the acquisition cost. And so the new loans have not been necessarily the issue. Those have been coming down in line with plan and continuing to get better as the months have gone on. We've really seen a quick rise. And I think in May is really when the consumer started feeling it the hardest. that's when inflation might have peaked at 9.1%. And we definitely were in a recession at that point. And we've done some interviews with our customers and surveys And, you know, it's just at the end of the day, prioritization of payments on our customers. They've got to pay for food, groceries, housing, you know, and kids and stuff like that. And so I think customers were stretched. But, you know, we feel really good that, you know, we're making all the right moves and that things are starting to get better. You know, right now we're seeing a lot of improvement, and we're feeling good and cautiously optimistic is, I guess, where we're at. And, you know, some of the things, David, that we're going to see – In the economy, states are starting to issue direct stimulus payments to customers. That's encouraging. Obviously, a lot of the states that we arrange loans in on behalf of our bank partners are eligible for those. And we really feel good about some of the redesigns of the payment portals that we have about giving customers more options for working out payments. So we're seeing a lot of positive things there. And I feel really positive. It's just we had a little headwind there in the second quarter. So, you know, ultimately, though, every other metric in the business is performing better than expected.

Got it, got it. And I appreciate the color. And maybe just in a follow-up, also related to credit, you know, I'm not sure if this is an operational or a technology-focused question, but, you know, we've obviously always – looked at an increasing auto-approval rate as always being a positive. And I'm wondering, as you think about some of the visibility challenges and tightening of underwriting, is an ever-increasing auto-approval rate something that you kind of always want to see when credit might be? Yeah. Is there sort of a ceiling on that rate?

That's a great question. I mean, so really, though, David, the underwriting process is the exact same for auto approvals that it is for someone who calls in. The people, that just means our technology is getting better. So we're taking out bottlenecks in the underwriting process and making the technology better for the consumer so they can go through the application process and get credit decision without having to talk to someone. It does not mean we're loosening standards or changing our standards, just to be clear, when it comes to auto approvals.

Got it. No, no. Appreciate the clarification.

Okay. Thank you.

Thank you. And we'll take our next question from Chris Brenler from DA Davidson. Please go ahead, Chris.

Hi. Thanks. Good afternoon. Not surprisingly, I want to follow up on the credit question as well. Just like, you know, as you went through the the months, you know, sort of starting in May, June, July into August, did it get worse? And is there any, you know, sort of can you stratify, you know, what were the issues might be from an underwriting perspective? Is it just that lower end or is it certain, you know, income levels? Like what is, you know, giving you the comfort that some of the changes you made are going to have an improvement here since we're still Kind of in the middle of this inflation picture.

Yeah, I mean, you know, back to what I was saying with David. So as you can tell, like after the first quarter earnings call, I was I was really bullish. I liked what I was seeing on the credit side. We had a good second quarter. Our gross charges as a percentage came down quarter over quarter by five or six percent. And we beat acquisition costs, we beat origination. So all positive. Starting in May, we saw a pretty quick decline in our existing book, which would definitely lead to reduced profitability. And we made a significant tightening in the first week of May based on those early indicator signs. So the year has kind of gone. It's been pretty volatile. But I think The customers really started feeling the inflationary pressure in May and even into June. And then in July, we made another significant, we actually made some tightening to our refinance population, which is pretty conservative to do, considering those customers are definitely the lowest delinquency set of customers and the pay rates are much higher. But we just wanted to be conservative and make sure that this was not going to be something that we had to deal with in the second half of the year and end. be conservative and kind of wait and see and be cautiously optimistic. But I think we're making all the right steps as far as dealing with with the spike in delinquency. I think what was surprising for on our end was the speed, right, at which the deterioration kind of happened, so the past due rate climbed so significantly, you know, quickly. And, you know, we did everything we can. But on the new loan side, we feel really good. I mean, that's something we can control because there's not existing principle already on our books. So when we evaluate new customers, You know, we feel really good about the weighted average risk score is down 1.5 points or even higher, 1.6 points from last year, which is like a totally huge significant shift in quality of new loans kind of being added to the book right now. Some of the highest quality are percentages of the lowest segments has increased significantly in dollars and percentage. And so, you know, we feel really good about, you know, what we're originating now. I think the existing book and some of the pressures of the inflation and the environment, you know, I think started to push the payment rates down a little, and that's what we saw. But, you know, like I said, we've seen some stabilization here. We see things getting better, and we're cautiously optimistic about, you know, getting some of this back in the second half.

Okay, I appreciate that. So it doesn't sound like that, you know, the problems are still like from a macro perspective. I would have thought like inflation would be, you know, a little bit of issue at first and then it would sort of crescendo from there as it persisted. But it sounds like it was more of an immediate impact in May and then didn't necessarily get worse in July and August, if that's correct. And then also, I was going to say, your current facility upsize was in June. So just, you know, maybe position the comments around the current picture, you know, around June. that transaction, which I thought was a really positive sign. You know, obviously the lender there got comfortable with the trend through June. You know, maybe just meet up there on the timeline.

Yeah. I mean, I mean, the thing is, is we have great financing partners that we have had relationships with now for, you know, for pretty much the existence of the business. And, you know, those relationships we've, we've performed well, Historically, for them, we've been great partners. We were out ahead of this, and we started tightening in November. Originally started tightening in November of last year, tightened again in January, tightened again in May pretty significantly. So I think, you know, our partners trust us and we have great relationships with them. And so they believe in what we're doing. And, you know, that that's that's been a real, real help for us as we continue to grow and expand and kind of go through some of this volatility.

OK, and then just the first part of the question, like. sort of the buckets or, you know, where we're seeing this? Like, is there any sort of insight? And how have you tightened? Is this not a matter of moving up among credit scores? And then one more, if I could. The originations are actually much stronger than we expected this quarter. So it's really strong. Is the demand, I would think, is really high and competitive conditions have improved. So you can tighten and still hit your top line numbers.

Yeah, that is absolutely. So not only that, our acquisition cost has come down. We're achieving, you know, had a plan on that, you know, almost 40 plus dollars year over year. I think there's even, you know, potentially some room for improvement there through the rest of the demand continues to be some of the strongest demand we've seen. But you got to be careful, right? You know, and so we've opted to slow down that growth to, you know, we could be growing a lot faster, but, you know, we're still putting guidance in the 20 to 25% range. and double down on quality here. So, you know, we're, what's happening is we're seeing customers that, you know, the average credit score increased about 40 points over the 2020, 2021 pandemic. That's because people were not accessing credit. They weren't inquiring for credit. We saw kind of a, our addressable market shrink. We're now seeing kind of the reversal of some of that where we're starting to see high quality customers kind of come back into, into our space and qualify for our products. So like I said, our, you know, we're originating the highest percentage and dollar amount of, of lower segment customers that we have probably since kind of the early days of the business when we kind of started to grow. So feel really good, right? Feel really good about that. And, you know, I think everything we're doing on the recovery side, on the payment side, to continue to support our customers that need to make partial payments or, you know, work with them through this tough time we're doing. And we're seeing great results, especially with some of the self-service stuff. that we've implemented and done some big technology releases. Another thing that we're doing that, you know, some of the other lenders I've seen have started using bank data. We've been using the bank data in our underwriting um for you know for the better part of seven or eight years now so we have incredible historical data and so we've completely um kind of revamped the credit model to really really focus on payment to income ratios i think ability to pay in this environment is vital for uh for to look at um especially when the customers are kind of you know, dealing with a large, you know, I think it's $9,000 to $10,000 of additional expenses per year. And so there is some wage growth, and, you know, we remain optimistic because unemployment remains low. And so that is the thing that gives us a lot of, you know, feeling good about some of this is that there is low unemployment. And our credit model, you know, and the enhancements that we've made over the year appear to be working very favorably.

Okay, great. Thanks, Tom.

As a reminder, that's star one if you do have a question or comment. Okay, and there appear to be no further questions at this time. I'd like to turn the floor back over to Todd Schwartz for closing remarks.

Okay, thank you. Well, listen, thanks, everyone, for joining us today. We're confident in the changes we are making to set us up for return to profitability in 2023. We look forward to speaking with you again during our third quarter earnings conference call in November. Thank you.

Thank you. Ladies and gentlemen, this does conclude today's teleconference. We thank you for your participation. You may disconnect your lines at this time and have a great day.