Open Lending Corporation (NASDAQ:LPRO) Q1 2023 Earnings Call Transcript May 13, 2023

Operator: Good afternoon, and welcome to Open Lending’s First Quarter 2023 Earnings Conference Call. As a reminder, today’s conference call is being recorded. On the call today are Keith Jezek, CEO; and Charles Jehl, CFO. Earlier today, the company posted its first quarter 2023 earnings release to its Investor Relations website. In the release, you will find reconciliations of non-GAAP financial measures to the most comparable GAAP financial measures discussed on this call. Before we begin, I’d like to remind you that this call may contain estimated and other forward-looking statements that represent the company’s view as of today, May 9, 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 Jezek. Please go ahead.

Keith Jezek : Thank you, operator, and good afternoon, everyone. Thank you for joining us today for Open Lending’s First Quarter 2023 Earnings Conference Call. For the first quarter, our results were ahead of our expectations despite the economic and industry dynamics impacting our business. We faced continued liquidity constraints at a majority of our credit union customers and the impact of rising interest rates on our business. We continue to experience demand-side challenges, specifically affordability, as near and non-prime consumers are being hit disproportionately by rising interest rates, resulting in lower disposable income. Consumer sentiment remains below its historical average. In addition, the used retail market for the past 2 years is as low as it has been in over a decade.

However, we are seeing modest signs of improvement in the new auto market since we last spoke in February. Now let me turn to our Q1 highlights. During the quarter, we certified 32,48 loans, generated total revenue of $38.4 million, gross profit of $32.9 million, and adjusted EBITDA of $21.2 million. We exceeded the high end of our Q1 guidance range for all metrics, certified loans, revenue, and adjusted EBITDA. I would like to thank all the team members at Open Lending for their contributions to these positive results. As I mentioned, the pandemic-related new automobile supply constraints are slowly improving. Specifically, semiconductor chip shortfalls have been mostly replenished. OEMs are running their plants with improved efficiency, transportation bottlenecks have eased, fleets have rebuilt their stock, and dealers are intelligently growing their new inventory.

Taking a closer look at the new auto retail market. At 16 million units, the new light vehicle in April was up 13.5% sequentially as compared to December and up 10% over April 2022. New vehicle inventory continues to expand, and in many instances, inventory is up nearly 70% year-over-year. Fleet sales also increased and are up 50% year-over-year and at 21.7% of total volume, the highest share since the pandemic. While improving new automobile dynamics are welcome news in the used retail market, sales declined 8% in April from March and were down 8% from a year ago. The recovery in new supply has been nonlinear and has fluctuated month-to-month. You supply is currently estimated at an average of 40 days, down from 49 days in January 2023. The used auto retail market continues to show signs of pent-up demand due to affordability factors facing near and non-prime buyers.

Consumers are holding on to their autos longer, but eventually, the increased maintenance and repair costs will be outweighed by the benefit of getting into a newer vehicle. We have seen this dynamic in prior cycles and note that the average age of a used vehicle on the road is over 12 years old, an all-time high. This pent-up demand will create an opportunity for open lending as used vehicle values moderate and interest rates decline. Like other consumer credit categories, auto loan delinquencies have continued to increase as a result of current economic conditions. Accordingly, we tightened our underwriting and in late March, increased our vehicle value discount factor. This action effectively increases our credit default insurance pricing to reflect and compensate us appropriately for the potential additional risk we are taking.

With this incremental adjustment, our average credit default insurance premium has increased by an additional 5%. Recall that this incremental premium is in addition to the 12% premium increase in the second quarter of 2022. As always, we will continue to monitor risk and portfolio performance, and we have the flexibility and ability to make additional adjustments. Now turning to other program underwriting changes we made in 2022 and early 2023, along with brief updates on each. In the second quarter 2022, we made changes to expand loan limits and extend the term of qualifying vehicles to 84 months. As of the first quarter of 2023, 84-month term loans comprised 15% of our volume, and importantly, claims to date are lower than expected since our initial rollout.

Their performance has yielded stronger unit economics based on higher credit default insurance premiums and better-than-expected performance due to lower claims than modeled. As you may recall, we put in place tighter payment to income or PTI constraints at the onset of the pandemic. And in the second quarter of 2022, we initiated our new PTI pricing program, where loans with higher PTI ratios are charged a higher premium and conversely loans with lower PTI ratios receive a discounted premium. Early performance shows this enhancement has better-aligned loss ratios across our program and is having a positive impact on volume. Earlier this year, we increased our allowable vehicle age from 9 to 11 years. I would point out that we did not increase the knowledge factor as this is the most significant driver of the depreciation of a vehicle.

This change provided a small increase to certified loan volume, but most importantly, reduced counter approvals, improved closure rates, and provided flexibility to our customers with the all-time high average age of used vehicles on the road without taking on much incremental risk. Along with the vehicle age update, we have reinstated our pre-pandemic policy for the loan approval exploration menu from 30 days to 45 days for our direct and refinance channels. This change offers our customers and partners sufficient time needed to complete their respective funding processes. Although we don’t have any direct exposure to the recent banking crisis, I wanted to take a moment to address the current banking landscape and, specifically, how it relates to smaller banks and more importantly, to our core customer credit unions.

The deposit outflows experienced by some of the recent regional bank failures have not been seen in credit unions. Furthermore, credit unions continue to lend to high-quality consumers, their members, and given that they fundamentally operate more conservatively when it comes to managing their balance sheet with very little leverage, they are not pressured to engage in the type of investment activity seen recently by some of the failed institutions as they are mandated to serve their members, not maximize returns. The type of loans underwritten by credit unions are more conventional in nature. In addition, it is more common for credit unions to have deliberate strategies when it comes to loan pricing from an asset and liability matching standpoint, which further strengthens their position through lending cycles, as evidenced during the great recession.

In fact, during that time, credit union deposits actually grew since they were viewed as a safer place by consumers to keep their money. On our last call, I shared our 2023 focus areas that we believe position us effectively for the current environment and market improvement as it comes. These are areas that support and strengthen our long-term competitive advantages and include further refining and optimizing our sales channels, enhancing our technology offering, and attracting and retaining talent. First, on sales, operations and marketing, we are seeing good progress from the investments we made in 2022. While we added 8 new accounts in Q1 of 2023 as compared to 18 in Q1 of 2022, we achieved our goal of shifting our results to closing larger volume accounts with a higher targeted share of the business to open lending.

The new accounts added during the quarter represent a 100% increase in average target share to us per financial institutions signed up as compared to Q1 of 2022. In addition, we continue to enroll financial institutions to operate loan origination systems for which we already have existing successful technology integration. As a result, we anticipate continued further improvement in streamlined workflow and onboarding processes to reduce the number of days to first revenue. Our marketing team has been instrumental in supporting our sales team with a strong lead generation program, including increased media presence in both earned and paid channels, thought leadership based on proprietary research, targeted personalized outreach to institutions, robust industry event participation to generate leads as well as the production of shareable campaign assets and other enabling sales tool.

We believe that we have the right resources in place to continue executing our go-to-market sales strategy that will position us well as the industry recovers. Our account management team remains focused on engagement and collaboration with our existing customer base to both solidify and expand their use of our program. During these uncertain economic times, our team members continue to work with our clients to reinforce the risk mitigation value our program offers, especially as it relates to the runoff of existing auto loans. One additional area of focus is assisting individual accounts and growing their lending footprint in their respective markets. We have also made strong progress on the technology front. In Q1, we completed the major milestone of deploying a new internal platform for claims adjudication.

This platform not only brings notable efficiencies to our adjudication process but also allows us to collect additional data needed for enhanced reporting and analytics. We’re in the process of completing a transition to the public cloud, which will allow us to grow in a cost-efficient manner, bring enhanced security to our framework, and offer access to services and technologies not readily available in our existing on-prem environment. To date, we have achieved all major internal milestones for this important initiative. Finally, a significant program design change was introduced in the quarter that will streamline workflows and significantly increase efficiencies for our partners and clients. As interest rates stabilize and our refinance channel volume returns, our lender partners will be positioned to support the expected larger volumes with lenders protection.

Lastly, on talent. We remain focused on building a strong people strategy to support and expedite Open Lending’s long-term growth objectives by hiring and retaining top talent. We will continue driving company culture centered on creating a diverse and collaborative environment to unlock value and foster growth for individuals, teams, and the business. That said, we will be measured and thoughtful as we add team members throughout the remainder of 2023. Having managed scaled businesses in the auto sector through the great recession, I continue to be encouraged by the response of our team and in our ability to manage through the current environment. I remain confident about our position in 2023 and beyond as we execute on our mission to help both lenders and underserved consumers.

I believe our value proposition to the various players in the auto retail ecosystem is as strong as ever. We remain committed to our goal of gaining market share by signing new accounts and expect to be well-positioned to meet pent-up demand as the industry continues to recover. Now with that, I would like to turn the call over to Charles to review Q1 in further detail as well as provide our thoughts on the outlook for Q2. Charles?

Charles Jehl : Thanks, Keith. During the first quarter of 2023, we facilitated 32,408 certified loans compared to 43,944 certified loans in the first quarter of 2022. The total revenue for the first quarter of 2023 was $38.4 million compared to $50.1 million in the first quarter of 2022. To break down total revenues in the first quarter of 2023, profit share revenue represented $18.6 million. Program fees were $17.3 million, and claims administration fees and other were $2.5 million. It is important to note that while our certified loan volume was down 26% in the first quarter of 2023 as compared to the first quarter of 2022, our program fee revenue was down only 12% due to a mix of business certified, which resulted in higher program fee unit economics.

Turning to profit share. I want to remind everyone that profit share revenue is comprised of the expected earned premiums less the expected claims to be paid over the life of the contracts, less expenses attributable to the program. The net profit share to us is 72%, and the monthly receipts from our insurance carriers reduce our contract assets each period. Profit share revenue in the first quarter of 2023 associated with new originations was $17.9 million or $552 per certified loan as compared to $25.7 million or $584 per certified loan in the first quarter of 2022. In first quarter 2023, we recorded a positive $0.7 million change in estimated future profit share related to business and historic vintages. The Manheim Used Vehicle Value Index, which tracks the prices car dealers-pay wholesale at auction for used cars is one of the industry factors we consider in evaluating our change in estimate each period.

As you may recall, this index fell nearly 15% in 2022, the largest 1-year decline in the history of the index. However, in the first quarter 2023, the index increased 6.2% as compared to December. This was an unseasonable increase for the Manheim not seen since 2008. Accordingly, this increase was a positive impact on our contract asset. Another positive factor impacting the contract asset was slower prepay speeds due to the elevated interest rate environment and loans remaining in the portfolio longer than expected. Both positive events were offset by higher-than-anticipated loan default stress applied to the portfolio as a result of rising auto loan delinquencies and projected claim frequency. In comparison, during the first quarter of 2022, revenue included a positive $2.6 million change in estimated future revenues on certified loans originated in historical periods.

Gross profit was $32.9 million and gross margin was approximately 86% in the first quarter of 2023, compared to $45.3 million and gross margin of approximately 90% in the first quarter of 2022. Selling, general and administrative expenses were $15.8 million in the first quarter of 2023 compared to $13 million in the first quarter of 2022 and compared to $17.2 million in the fourth quarter of 2022. The increase year-over-year is primarily due to additional team members to support our focus on our go-to-market sales strategy and investment in our technology. The decrease from the fourth quarter 2022 is a result of our measured and controlled approach to incurring incremental cost in the current environment. Operating income was $17.1 million in the first quarter of 2023 compared to $32.2 million in the first quarter of 2022.

The Net income for the first quarter of 2023 was $12.5 million compared to net income of $23.2 million in the first quarter of 2022. Basic and diluted earnings per share was $0.10 in the first quarter of 2023 as compared to $0.18 in the previous year quarter. Adjusted EBITDA for the first quarter of 2023 was $21.2 million as compared to $33.8 million in the first quarter of 2022. There is 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 $372.9 million in total assets, of which $210.6 million was in unrestricted cash, $65.9 million was in contract assets, and $63.9 million in net deferred tax assets. We had $167.3 million in total liabilities, of which $146.6 million was an outstanding debt.

We generated $27.5 million in cash during the quarter before repurchasing 3.1 million shares of our common stock for approximately $21.3 million at an average price of $6.87 per share. We have approximately $36 million remaining under our board-approved share repurchase program. Now moving on to our guidance for Q2 ’23. While supply may have troughed and began improving, our near and non-prime consumers are continuing to feel the impact of high financing costs compared to a year ago and the upward pressure on affordability and overall demand. We are continuing to monitor our data, looking for indications that affordability is beginning to stabilize, but this continues to be a challenge. The auto sector has clearly felt the effects of the Federal Reserve’s initiative to tighten monetary policy.

Conversely, should the Fed lean more dovish going forward, we would expect to see an improvement in our business based on our analysis of prior recessionary cycles. Until we have more visibility and certainty into our customers’ auto portfolio growth, we feel it continues to be prudent to provide guidance on a quarterly basis. Guidance for the second quarter of 2023 is as follows: total certified loans to be between 29,000 and $33,000, total revenue to be between $33 million and $37 million, and adjusted EBITDA to be between $16 million and $20 million. In our guidance, we have taken the following factors into consideration, the affordability index of our target credit score borrower due to the continued elevated used car values, inflation, elevated interest rates compared to a year ago levels, and the financial condition of the near and non-prime borrower.

We have a strong balance sheet, which has allowed us to thoughtfully invest in our business and repurchase our common stock at attractive prices. While maintaining financial flexibility that will position us very well as demand fundamentals improve. We would like to thank everyone for joining us today, and we will now take your questions.

Q&A Session

Operator: [Operator Instructions] The first question comes from the line of David Scharf with JMP Securities.

Operator: The next question comes from the line of Bob Napoli with William Blair.

Operator: The next question comes from the line of Joseph Vafi with Canaccord.

Operator: [Operator Instructions] Your next question comes to the line of Vincent Caintic with Stephen.

Operator: The next question comes from the line of Peter Heckmann with D.A. Davidson.

Operator: [Operator Instructions] We now have a question from the line of John Davis with Raymond James.

Operator: And we have a follow-up question from Bob Napoli with William Blair.

Operator: There are no further questions at this time. I’ll now turn the call back to you. Please continue with your presentation and our closing remarks.

Keith Jezek : Well, I want to thank everybody for joining us today. We’re pleased with the results that we just exhibited for Q1. And again, I want to send a sincere and heartfelt thank you to all of the Open Lending employees that made it possible. Thank you.

Charles Jehl : Have a great day. Thanks for joining us.

Operator: That does conclude the conference call for today. We thank you for your participation and ask you to please disconnect your line.