Flexshopper - Q3 2023

Transcript

Operator (participant)

Greetings. Welcome to the FlexShopper Third Quarter Financial Results Conference Call. At this time, all participants are on a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. I will now turn the conference over to your host, Carlos Sanchez of Investment Relations. You may begin.

Carlos Sanchez (Investor Relations)

Thank you, and good morning. Welcome to FlexShopper's Third Quarter 2023 Financial Results Conference Call. With me today are Russ Heiser, our Chief Executive Officer, and John Davis, our Chief Operating Officer. We issued our earnings release yesterday and corresponding investor relations presentation this morning, and we'll be referencing these during the call today. Both can be found in our investor relations section of our website. We will be available for Q&A following today's prepared remarks. Before we begin, I would like to remind everyone that this call will contain forward-looking statements regarding future events and our financial performance, including statements regarding our market opportunity, the impact of our growth initiatives, and future financial performance.

These should be considered in conjunction with cautionary statements contained in our earnings release in the company's most recent periodic SEC reports, including our quarterly report, 10-Q, for the quarter ending September 30, 2023. These statements reflect management's current beliefs, assumptions, and expectations and are subject to a number of factors that may cause actual results to differ materially from those statements. Except as required by law, we undertake no obligation to publicly update or revise any of these statements, whether as a result of new information, future events, or otherwise. During today's discussion of our financial performance, we will provide certain financial information that contains non-GAAP financial measures under SEC rules. These include measures such as EBITDA, net income and adjusted net income. These non-GAAP financial measures should not be considered replacements and should be read together with our GAAP results.

Reconciliation to GAAP measurements and certain additional information are also included in today's earnings release, which is available on the investor section of our website. This call is being recorded, and a webcast will be available for replay on our investor relations section of our website. I will now turn the call over to our CEO, Russ Heiser.

Russell Heiser Jr. (CEO)

Thanks, Carlos, and good morning, everyone. Thank you for joining us. Yesterday, we reported Q3 financial results that are, on the whole, a good bit better than prior quarter in the same quarter last year. EBITDA increased over $11 million versus the same quarter last year, and net income was up over $7 million versus the same quarter last year. We continue to be in a difficult operating environment, with inflation continuing to significantly impact our customer base, but balanced by an economy that still hasn't experienced meaningful job loss in the non-prime sector. Out of an abundance of caution, we continue to be selective in our underwriting and are very active in monitoring and managing our portfolio to provide significant cushion if the environment and customer payment behavior does start to move away from us.

While historically, our customers have demonstrated resilience in a recessionary environment, we face uncertain times and want to be positioned for any negative shifts, whether from the resumption of student loan payments or continued deterioration of the economy. FlexShopper has continued to evolve its direction over the last several months. We are leaning into the direct-to-consumer marketplace as our primary growth engine going forward. We have worked diligently over the last two quarters to evolve from utilizing our website solely as a method of generating leases. We are transitioning to a more fulsome e-commerce site that focuses on merchandising efforts to enable the company to profit not only from generating leases on our site, but also capturing a retailer margin on more of our goods.

Furthermore, we have worked to increase conversion opportunities on our site by enabling risk-based pricing initiatives that recognize that all of our customers are not the same or fit into a single lease-to-own offer while maintaining attractive asset level returns. Studying that idea even further, we are exploring partnerships with other financing channels to provide an even broader selection of purchase options to consumers that do not have the current liquidity to transact on more traditional e-commerce platforms. FlexShopper is positioning itself as a marketplace with an assortment of payment options for the larger universe of credit-challenged consumers that will extend beyond our historical lease-to-own options. In addition, we are utilizing Generative AI tools to create smaller versions of our main site focused on product verticals. These microsites are expected to provide significant marketing leverage that will allow us to reach and monetize customers at decreased acquisition costs.

With all these changes in place, we believe FlexShopper and our marketplace will have greater control of its growth opportunities. First, it allows us to direct marketing spend where it is most efficient. A marketing spend online is only constrained by acquisition cost and achieving the appropriate return on capital, unlike other verticals where we might be dependent upon foot traffic to a store. Second, it allows us to be focused on achieving the ideal asset level return without trying to hit benchmark approval rates or spending limits, as can occur with our enterprise customers. This doesn't mean that we aren't continuing to grow the direct brick-and-mortar and online enterprise relationships. In fact, a lot of the technologies developed for our marketplace are providing more value to our large enterprise customers and permitting higher approval rates and conversion rates among these customers.

Our enterprise experience continues to result in big wins, and we are in the final stages of another 1,000-plus store contract that will grow our enterprise leasing originations by at least 25%. We just want to be thoughtful in terms of making sure that we don't chase new doors or originations, instead, stay focused on the bottom line. Finally, the storefront lending business that we acquired late last year is gaining momentum. As we have mentioned in the past, the goal is to develop a framework that can allow us to reach large, non-prime customer segments with our combination of state-licensed and lease-to-own products, complemented by other liquidity providers. We continue to believe that by providing the widest assortment of products and payment options to consumers, we can leverage and grow the exclusive arrangements we have with a wider assortment of retailers and service providers.

Looking forward to the holiday season and early next year, we expect to see continued growth in originations as a result of our improvements to the FlexShopper Marketplace and new enterprise partners. Combined with a focus on asset level performance, our allowance for doubtful accounts as a percentage of gross billings will decline, resulting in a leap forward in net revenue. The continued merchandising efforts should continue to increase the margin on our products, resulting in relative declines in the depreciation of lease merchandise. All this will enhance gross profit over the near term. The management team at FlexShopper believes we are at an inflection point in the business and look forward to demonstrating our progress going forward. With that, I will turn the call over to our COO, John Davis.

John Davis (COO)

Thanks, Russ. We continue to be pleased with the asset quality of both our lease and loan segments. As we have mentioned in previous calls, the transition from government stimulus coming out of the pandemic to a high inflationary environment was difficult for our customers. During this time, our efforts were targeted towards improving bad debt levels on our lease channel, continuing to develop enterprise and smaller partnership distribution opportunities, expand retail margins within our marketplace lease channel via manufacturer and distributor partnerships, and continue to develop our state model lending business through our Revolution Finance platform. I am pleased with the results of all of these activities to setting up FlexShopper to achieve sustainable, profitable growth. Lease fundings were 4% higher versus Q2 of 2023, and 11% lower versus Q3 of 2022.

An important point to note is that September lease fundings were higher year-over-year, which was the first monthly positive comp since July of 2022. October lease fundings were also higher year-over-year, and had the highest lease dollar funding for all of 2023. November is also trending higher year-over-year as of the middle of the month. Gross lease billings and fees were 19% lower year-over-year, or $7.3 million lower versus last year. As a reminder, this line item has a lag to fundings as this revenue is recognized over the term of the lease. The key factor in the asset profitability of our lease business include gross lease billings and fees, provision for doubtful accounts, depreciation and impairment of lease merchandise and market.

While we look at these components, we are seeing improvements based on the initiatives we have been undertaking. The provision for bad debt expense was $10.2 million in Q3 of 2023, versus $14.1 million in Q3 of 2022, which was an improvement of $3.9 million year-over-year. As a percentage of gross lease billings, 2023 Q3 was 32.6% versus 36.5% for the same quarter last year, or a 390 basis point improvement year-over-year, even with including some sales of delinquent receivables last year, which did not occur this year. This improvement is a result of our underwriting tightening, as well as continued enhancements to our fraud and credit risk capabilities and strategies.

We have recently upgraded our operational leadership team, as well as adding new collection agencies to work on our past due portfolios. We expect that this new leadership and capabilities will result in continued improvement in past due liquidations, which will provide future support to keeping this expense trending in a favorable way. Depreciation and impairment of lease merchandise expense was $13.1 million in Q3 of 2023, versus $18.8 million in Q3 of 2022, or $5.7 million lower year-over-year. As a percentage of gross lease billings, 2023 Q3 was 41.8% versus 48.6% for the same quarter last year, or a 680 basis point improvement year-over-year.

This is the result of the rollout of our retail product margin initiatives into the portfolio, which, in a similar way to gross lease billing and fees, is spread out over the life of the lease. We are constantly evaluating the selection of products that we offer to better match our customers' wants and needs, as well as to continue to improve gross product margin on what we sell. Additionally, we are investing in our technology platform to add flexibility and scalability to this important initiative, which is already adding significant value to the company. Marketing costs were $1.7 million in Q3 of 2023, versus $2.4 million in Q3 of 2022, or $700,000 lower year-over-year. Importantly, total marketing spend was 30% lower year-over-year, while funding was only 11% lower year-over-year.

We are seeing more efficiency in our marketing efforts in comparison to last year, with the difference between year-over-year spend and origination volume. We are continuing to improve this efficiency by way of testing new marketing partners for better targeting and personalization, adding new capabilities in generative AI content creation on our marketplace to increase traffic and conversion, and price testing on both our products as well as our lease costs to optimize revenue and risk. Adding all these components up, our lease revenue less provision for loss, depreciation of lease goods, and marketing was $6.4 million for Q3 of 2023, versus $3.4 million for the same quarter last year, or $3 million better year-over-year. With the underlying components of our lease business at favorable levels, our goal now is to increase revenue.

As I mentioned earlier, lease funding levels in September and October were up year-over-year, which will, if that trend continues, eventually result in higher top-line lease revenue. We are also introducing new financing and payment option partners on our marketplace that will allow for increased revenue from retail product margin and customers that either do not convert with our lease pricing or customers that we decline, the subsequent funding partner approves. We expect little cannibalization on our lease origination as our partner payment offerings are controlled from a credit profile standpoint to minimize overlap. On the enterprise and smaller partnership point-of-sale lease channel, our partner door count that had our lease product available increased approximately 15% from last quarter. We expect that this will continue into Q4 of 2023 and into 2024, with new potential partners currently in different stages of discussion.

We are excited about this growth channel, not only for the direct revenue that these partnerships provide, but for the increased customers that may also take advantage of our marketplace offerings. On our lending front, we originated $14.8 million in Q3 through our Revolution Finance platform and $0.1 million through our loan participation program. This compares to $10.4 million in Q2 of last year in our loan participation program, with no originations through Revolution, which we acquired in Q4 of last year. As a reminder, we issue consumer loans within approximately 100 storefronts, consisting of owned physical locations and virtual locations within Liberty Tax stores using state lending licenses. We are seeing incremental growth within Revolution, with a 6% increase in originations from last quarter and a 42% year-over-year increase in overall lending related to the fundings.

Similar to our lease operations, we have invested in leadership within the Revolution platform and expect growth to accelerate into Q4 this year and into 2024. As we invest in our leadership team, our technology capabilities, and our servicing and lease and loan distribution partners, we expect to simultaneously achieve top-line growth and favorable economics within the P&L. To that end, we saw an increase in our bank participation portfolio collections due to our investments in operations and agency partnerships that I mentioned earlier, which has resulted in a $7.1 million positive net change in the fair value of loan receivables due to higher future expected cash flows from the portfolio. As we continue with these investments in people, strategy, and technology, I'm personally very excited about what our business can do.

With that, let me turn the call back over to the operator for any questions.

Operator (participant)

Thank you. At this time, we will be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from the line of Scott Buck with H.C. Wainwright. Please proceed with your question.

Scott Buck (Managing Director and Senior Technology Analyst)

Hi, good morning, guys. Thanks for taking my questions. First one, on the enterprise door rollout, can you remind us what, you know, the typical kind of cadence is, for those, you know, relationships to mature? I mean, is it six months, or 12 months before, you know, you really start to see some momentum there?

Russell Heiser Jr. (CEO)

Good morning, Scott. I wish it was, you know, as simple as having a standard cadence for all of these enterprises. You know, we have, you know, a recent one that just fully rolled out into about 600 locations, and it was a pilot for six months. And then as, you know, we started a fuller rollout, and then it was just paused for the summer, and then took a little while. So that entire process was probably 15 months or so. This most recent one that I mentioned on the call earlier was probably it'll be five months from start to finish, so it doesn't really have a fixed pattern. I think the...

Our approach has been, let's, you know, look for opportunities where we can, you know, achieve at the right acquisition cost, you know, the sort of right type of growth to expend resources to focus on it, and hope to continue to add, you know, in the area of 1,500-2,000 stores a year. It looks like we've, for the past couple of years, we've done a little bit better than that.

Scott Buck (Managing Director and Senior Technology Analyst)

Great. That's helpful, Russ. And then a second one: Can you give us an update on the competitive environment? Anybody encroaching on your space, or are you seeing anybody act, you know, generally more aggressively?

Russell Heiser Jr. (CEO)

What we've seen actually is a pullback in a couple of our sectors as the bank partnership programs have become a little bit more difficult to sustain, as more banks have, you know, ended those programs. We've seen some pullback there.

... I think all of it is about choosing, you know, the right verticals. Obviously, some are more contested than others, but no new entrants.

Scott Buck (Managing Director and Senior Technology Analyst)

Great. Then just last one from me. If you could give us some kind of an update on where we are in the fourth quarter versus, you know, what we've seen historically with the, you know, seasonal bump, I guess, in originations.

Russell Heiser Jr. (CEO)

Sure. I'll let John take this one.

John Davis (COO)

Yeah. We are pretty pleased with what we're seeing early. You know, I had mentioned earlier in my prepared remarks, you know, September had a positive comp, and this was both on our enterprise side as well as our marketplace. And we're actually seeing those comps increase as we are getting closer and closer to the holiday period. Our holiday period really accelerates from, you know, Black Friday into Cyber Monday and then, you know, peaking probably mid-December. But if we compare the trend coming into the festive period, we are favorable to what we've seen in the past couple of years.

Scott Buck (Managing Director and Senior Technology Analyst)

Great, that's helpful. I appreciate the added color, guys. Thank you. Thank you again, and congrats on the quarter.

John Davis (COO)

Thanks.

Operator (participant)

Our next question comes from the line of, Michael Diana, with Maxim Group. Please proceed with your question.

Michael Diana (Managing Director and Senior Research Analyst)

Okay. Thank you. Hey, Russ.

Russell Heiser Jr. (CEO)

Morning.

Michael Diana (Managing Director and Senior Research Analyst)

Actually, I was gonna ask about the same two topics, so let me just ask a little different question. So on the, on the 1,000-store enterprise rollout, did I hear you correctly in saying that you think this should increase your lease volume by 25%?

Russell Heiser Jr. (CEO)

Sure. And, the enterprise lease volume by 25%.

Michael Diana (Managing Director and Senior Research Analyst)

Okay.

Russell Heiser Jr. (CEO)

Yeah.

Michael Diana (Managing Director and Senior Research Analyst)

Okay. Right. And I guess you just said you expect that program to be fully up and running in about five months, right? So, well, it should impact the holiday season that's coming on here, but it won't be fully rolled out. Is that right?

Russell Heiser Jr. (CEO)

That's correct. I would expect the... As you can imagine, our retailer partners have a lot of priorities during the holiday season. It's not always our rollouts, but it should be fully rolled out before the end of the first quarter.

Michael Diana (Managing Director and Senior Research Analyst)

Okay. And then that relates to my next question, which is: So you're obviously expecting a big holiday quarter in the fourth quarter. Do you expect the first quarter of 2024 to evidence the typical big downturn, or because of everything you've been doing lately, it may be less of a falloff?

John Davis (COO)

Hey, this is John. Yeah, I mean, you typically will see a drop from Q4 to Q1. But if the trends continue as we're seeing them right now, we're expecting a higher year-over-year Q1, you know, versus 2023. Yeah, but you'll always see that seasonal downtick. You know, roughly 40% of our origination volume comes from Q4 every year. So obviously, it's a very important season. But the good thing about, especially these enterprise rollouts that we're bringing online, those are not as seasonally dependent. You know, if you look at a tire store, that is a year-round sale for us. So, that should help us smooth out our overall lease origination line.

Michael Diana (Managing Director and Senior Research Analyst)

Okay, great. Thank you very much.

Russell Heiser Jr. (CEO)

Thank you.

Operator (participant)

We have reached the end of the question and answer session. I'll now turn the call back over to management for closing remarks.

Russell Heiser Jr. (CEO)

We appreciate everyone dialing in this morning. We want to thank the team for all their hard work over this past quarter and the results it generated, and we look forward to a great holiday season and catching up with you all to report our full year results shortly.

Operator (participant)

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.