Flexshopper - Q3 2024

Executive Summary

• Record quarter: total revenues rose 22.9% to $38.6M, gross margin expanded 400 bps to 58%, adjusted EBITDA increased 44.9% to $12.2M, and diluted EPS turned positive at $0.05.
• Asset quality drove profitability: provision for doubtful accounts fell to ~22% of gross lease billings (vs ~32% LY), aided by improved underwriting, customer mix, and servicing capabilities.
• Distribution flywheel accelerating: signed store count reached ~7,800 locations (≈250% YTD growth), including >3,700 Auto Parts Alliance doors; management expects further partner additions.
• Capital structure actions are a potential stock catalyst: proposed rights offering and option to redeem 91% of Series 2 preferred at a 50%+ discount could lift annual net income and reduce interest/dividend burden materially.

What Went Well and What Went Wrong

What Went Well

• Record revenue and EBITDA with return to GAAP profitability: “record quarterly total revenue of $38.6 million… adjusted EBITDA… $12.2 million… net income attributable to common stockholders of $1.2 million or $0.05 per diluted share”.
• Gross margin expansion from retail marketplace strategy and asset quality: gross margin rose to 58% (vs 54% LY, 50% in Q2); depreciation as % of gross lease billings improved and provision rates fell YoY.
• B2B partner momentum: “signed store count of approximately 7,800 locations… nearly 250% increase… upcoming rollout of over 3,700 new locations” and new partnerships (Auto Parts Alliance, Monro via PayTomorrow).

Management quotes:

• “Third quarter… record of nearly $39 million… adjusted EBITDA… more than $12 million… net income… $0.05 per diluted share”.
• “Provision for doubtful accounts… 22.2% in Q3 2024 vs 32.1% in Q3 2023—a 990 bps improvement”.
• “Our signed store count… approximately 7,800… includes… over 3,700 new locations associated with… Aftermarket Auto Parts Alliance”.

What Went Wrong

• Loan revenue softness and partner exit: net loan revenues declined YoY (Q3: $9.0M vs $10.3M), with bank partner exiting high-APR business; state-licensed lending origination counts down 8% YoY.
• Interest burden remains heavy: interest expense rose to $5.67M (vs $4.75M LY), underscoring the need for deleveraging; rights offering targets interest and dividend reductions.
• Metric inconsistency on approvals: press release cites total lease funding approvals at $122.2M (up 111%), while call remarks cited $77M (up 33%); indicates definitional or reporting timing differences to monitor.

Transcript

Speaker 0

Ladies and gentlemen, good morning and welcome to the FlexShopper, Inc. third quarter earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star and zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Burger, from Investor Relations. Please go ahead.

Speaker 3

Thank you, Ryan, and good morning, everyone. Welcome to FlexShopper's third quarter 2024 financial results conference call. With me today are Russ Heiser, our Chief Executive Officer, and John Davis, our Chief Operating Officer. We issued an earnings release this morning, which we'll be referencing during today's call. Our earnings release can be found on 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 financial performance, including statements regarding our market opportunity, the impact of the growth initiatives underway, and future financial performance. These statements should be considered in conjunction with cautionary statements contained in our earnings release and the company's most recent periodic SEC reports, including our annual report and most recent 10-Q.

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 may undertake no obligation to publicly update or revise any of these statements, whether as a result of any 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 of these measurements and certain additional information are also included in today's earnings release, which is also available on the Investor Relations 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. Russ, go ahead.

Speaker 1

Thank you, Andy. And thanks to everyone for joining us for this morning's call to review our third quarter performance. I'll start today's call with an update on the growth strategies we are pursuing, and then we'll turn the call over to JD, who will discuss our operations and financial results in more detail before we take your questions. Third quarter was an exceptionally busy period, demonstrating the growing momentum underway across our business. As a result, we believe 2024 is shaping up to be a transformative year for FlexShopper, as the strategies we are pursuing to profitably grow our business take hold, and more retail partners and consumers recognize the value of our unique payment solutions. More importantly, our strong third quarter results reflect the hard work and commitment of our team members.

As we mentioned last quarter, we have pursued strategies to expand our financing options, which have resulted in a full suite of payment solutions within our digital marketplace. Today, our platform consists of traditional lease-to-own offerings, unsecured consumer loan products, and our traditional e-commerce retail business with a growing range of financing options. In addition, we offer our diverse payment solutions to customers directly through our website, as well as through partnerships with leading e-commerce and brick-and-mortar retailers in the automotive, electronics, and pawn spaces. After making meaningful investments across our business, including enhancements to our internal underwriting, collections, and account servicing capabilities, we are now focused on pursuing proactive growth strategies within our B2C and B2B channels.

Our third quarter of 2024 results demonstrate the successful transformation underway, as we increased total revenue 23% to a quarterly record of nearly $39 million, increased adjusted EBITDA by 45% to a quarterly record of more than $12 million, and produced net income attributable to common stockholders of $1.2 million, or $0.05 per diluted share. So let's look at the third quarter's performance in more detail, starting with the growth in our B2B channel. Trends within our B2B business are accelerating as we partner with more payment platforms and retailers. To date, we have announced new partnerships with leading payment platforms, including PayTomorrow, Terrace Finance, Versatile Credit, and PayPossible. As these platforms integrate FlexShopper into their payment waterfalls, we can leverage their networks to provide our leading LTO solutions to their merchant partners. In addition, we continue to pursue retailers directly that need an LTO solution.

As a result of our efforts, total lease funding approvals compared to the prior year period increased 33% during the third quarter to $77 million. To date, we have a signed store count of approximately 7,800 locations, a nearly 250% increase from approximately 2,300 retail locations at the end of 2023. This includes the upcoming rollout of over 3,700 new locations associated with our recent partnership with the Aftermarket Auto Parts Alliance. We have also recently announced retail partnerships with Randy's Worldwide and Monro. Location growth has exceeded our projections. We have a strong pipeline of potential payment and retail partners, and we expect to announce new partners in the coming months. Higher demand for our payment solutions is being driven by the investments we have made to our platform and the growth strategies we are pursuing.

In addition, as other lenders have tightened their credit box, we believe we have opportunities to provide our retail partners with the resources needed to capture incremental customers. Looking at our emerging B2C marketplace, we continue to pursue growth strategies to increase sales at flexshopper.com, which is the leading LTO marketplace in the industry. We have added new capabilities that allow customers on our website to receive payment options that fit their credit profile. In conjunction with this, we have broadened the product assortment available for sale on flexshopper.com. This expanded marketplace is resonating with consumers and broadens our addressable market to serve more customers, regardless of their credit score. Since launching these capabilities during the first quarter of 2024, we have seen steady growth in retail revenue increase from $780,000 for the quarter ended March 31st, 2024, to $1.2 million for the quarter ended September 30th, 2024.

We continue to test, learn, and adjust our approach to focus on profitably growing retail sales. We plan to expand our marketing spend to drive traffic and increase conversion. Based on our recent performance and the strategies we're pursuing to grow the FlexShopper marketplace, we expect retail revenue to continue increasing over the coming quarters. We also continue to add more SKUs and product categories to the FlexShopper site to gain a larger share of our customer spend. We continue to expand in the furniture category, supported by LTL freight shipping, and we have launched personal luxury categories such as handbags, sunglasses, and watches. In addition, we continue to look at launching micro-sites that have the potential to reach more customers than a single flexshopper.com marketplace site. It is important to note that we do not take inventory of any products offered on our websites.

We have developed strategic relationships with distributors and manufacturers who dropship products directly to customers. We believe this provides us with a competitive advantage by eliminating inventory risks and reducing the capital requirements of our business. This, in turn, allows us to invest capital to support our technology roadmap, marketing programs, and loan and lease growth. As you can see, positive growth trends are underway, and we feel really good about the direction of our business. Before I turn the call over to JD to provide more detail on our performance, I want to review important actions that we have recently announced, including the patent infringement lawsuits we filed against two of our competitors, the opportunity to redeem our Series 2 Preferred Stock, and I'll review the proposed Rights Offering at the end of the call.

As we've outlined historically, FlexShopper has invested heavily with both our time and capital to create an innovative next-generation LTO platform, and the five issued patents we have received are central to our business and strategies. As a result, we have retained Quinn Emanuel Urquhart & Sullivan to represent the company. We filed initial patent infringement lawsuits in the U.S. District Court for the Eastern District of Texas against Upbound and Katapult. The lawsuits revolve around five key patents granted between 2018 and the present, which protect FlexShopper's online LTO technology. The lawsuits against Upbound and Katapult were initially filed on September 30th. Investors should read our complaints to gain more insight into our rationale and position. We look forward to these two lawsuits moving forward quickly and will be updating investors along the way. Going forward, we plan to vigorously defend against LTO competitors who are infringing on our patented technologies.

The next action I want to review today is the opportunity to redeem 91% of our Series 2 Preferred Stock. This preferred stock is the last remaining investment from a fund that is winding down. As a result, we have the opportunity to redeem a majority of our preferred stock at a greater than 50% discount to its liquidation value of $44 million as of September 30th, 2024. We believe this opportunity will enhance shareholder value by improving our cost of capital, simplifying our capital structure, and transferring the discount of $23 million of equity value to our common shareholders, representing approximately $1 per share. In addition, the redemption of our Series 2 Preferred Stock will be highly accretive to earnings and will contribute over $4 million to annual operating income. The 50% discount is based upon the date of repayment, and the option to purchase lasts for a one-year period.

In addition, further payments to the seller of the preferred stock may be required based upon the purchase price and a change of control in the next 12 months or patent settlement announcements in the next 24 months. We are working hard to redeem the Series 2 Preferred Stock owned in the near term so common shareholders can unlock this significant value. We believe our third quarter performance demonstrates the significant transformation underway at the company. The positive momentum and favorable trends underway across many aspects of our business are supporting additional opportunities to create significant value for our shareholders in 2025 and beyond. I'm excited by the direction we're headed, and I look forward to updating our investors on FlexShopper's success in the months ahead.

Before I turn the call over to JD, I want to apologize for our last-minute earnings release and mention that Grant Thornton may need additional time to finalize the audit of the company's third quarter financial results. If so, we plan to file an automatic extension with the SEC later today. We'll file our 10-Q for the quarter ended September 30th, 2024, within the five business day extension window. We don't anticipate any changes to financial results presented in our earnings release or communicated in today's conference call. So with this overview, I'll hand the call over to JD to dive into the company's third quarter performance.

Speaker 2

Thanks, Russ. As I've stated on prior calls, our long-term plan for our lease business consists of three key items. First, we want to improve overall asset quality from the more challenging time periods where removal of government stimulus, reduced savings, and higher consumer price inflation caused a deterioration in payment performance. Second, we want to continue to roll out our online retail strategy where we realize product margin revenue on the products we sell on our flexshopper.com marketplace. And third, we want to take these quality originations and grow them. Our strong third quarter revenue growth and the significant improvement in profitability demonstrates the progress we are making executing against these strategies. Let me start with asset quality. The provision for doubtful accounts as a percentage of gross lease billings and fees was 22.2% in Q3 of 2024.

This compares to 32.1% in Q3 of 2023, which was a 990 basis points improvement or a 30.8% reduction year over year. Improved asset quality drove a $2 million benefit in the third quarter provision compared to the same period last year. New originations continue to demonstrate favorable early payments versus the same period last year, which suggests that the provision level should continue its year-over-year favorability into Q4, absent any unforeseen short-term macroeconomic impacts. I'm pleased with the quality of originations today, and we are accomplishing our first goal of continued asset performance improvement. Regarding our online retail strategy, we continue to realize the benefits of introducing product margin to our business, enabled by our flexshopper.com marketplace.

Our depreciation and impairment of lease merchandise cost as a percentage of gross lease billings and fees continued to improve and was 39.8% in Q3 of 2024, compared to 41.8% in the same quarter last year. This is a 200 basis point improvement year over year as our product margins continue to improve and mature into the portfolio. Overall depreciation and impairment costs increased by $1.4 million year over year, but this is due to a significant increase in lease revenue of $5.1 million. Adjusting for this year-over-year revenue increase, this improved product margin improved lease profitability by $2.1 million this year versus the same quarter last year. In addition, our third quarter gross profit expanded 32.9% year over year. This produced a 58% gross margin in Q3 of 2024, compared to 54% in Q3 of 2023 and 50% in Q2 of 2024.

The significant growth in gross profit and gross margin is a direct result of the strategies we are pursuing to capture retail revenue and margin. I'm pleased with our progress on our second goal of improving gross margins, and we continue to work on adding higher product margins to higher margin products to a marketplace, including furniture, mattresses, jewelry, and personal luxury items. We now offer multiple payment solutions on our marketplace, which provides more options for customers to transact on the marketplace with an offer that fits their credit profile and what they can obtain from another credit provider. We are working to expand this panel of payment providers to attract a broader range of customers that should increase interest and subsequently sales on flexshopper.com.

This includes a large prime credit issuer to expand our total addressable market to levels beyond the traditional subprime customer and increase online traffic of customers that already visit our site daily. Providing a full spectrum of payment options on our marketplace can dramatically increase overall revenue, provide a positive impact in the quality of our lease originations, and increase our marketing efficiency. Every incremental sale on our marketplace to customers outside our traditional LTO offerings expands income and cash flow that is immediately recognized versus amortized over a 12-month lease. Let me now discuss our third goal of increasing profitable revenue. Overall net revenue grew by 22.9% year over year for Q3 versus to $38.6 million. Gross lease revenues increased $5.1 million versus Q3 of 2023 to $36.4 million, with total net lease revenues increasing by $7.3 million versus last year's Q3 to $28.4 million.

This year-over-year increase in lease revenue accelerated from Q2, where comparative gross lease revenue grew by 6.7% year over year a quarter ago and is up by $1.7 million from Q2 of 2024. Lease revenue is being fueled by a 14% increase in lease origination dollars compared to last year, which is coming from both increased lease counts and higher average lease value. As Russ mentioned earlier, our signed store count is approximately 250% higher than the beginning of the year. With approximately 7,800 locations, our location count has blown by our original target of 5,000 by year-end 2024. The unique competitive advantage that FlexShopper has versus other companies in our industry is our marketplace, which greatly enhances our ability to drive repeat originations versus a model that is mainly retail-focused only.

As we add more new customers to our ecosystem through this expanding location base, marketplace revenue will also benefit from repeat purchases beyond our direct-to-consumer marketing efforts. Total lease funding approvals were 33% higher at $77 million in Q3 of 2024 versus $57.9 million in Q3 of 2023. Submitted applications were 58% higher year over year, showing the impact of strong consumer demand and our increasing location counts. Our marketing team has developed a robust remarketing engine, which will enable approved customers to more easily use their available spending limits on our marketplace during the upcoming holiday shopping season. Overall, net loan revenues were $9 million this year versus $10.3 million last year. Net revenue in our state-licensed business model increased 249% versus last year, while net revenues from our bank partner loan model dropped to a loss of $190,000 versus a $7.7 million gain last year.

Our bank partner chose to exit the high APR business in 2023. Our state-licensed lending business was acquired in December 2022 and consists of branch-based loan distributions among owned and operated as well as third-party franchise-owned locations. In Q3, we recorded a gain on the fair value estimate of the portfolio as many of these loans were placed with a new third-party collections partner that is demonstrating improved cash collections. Overall origination counts were down at 8% in Q3 versus the same period last year. The new customer origination dollars were up 32% year over year in September and 28% year over year in October. This improvement in new customer originations is in part due to new leadership we brought in in the middle of the third quarter.

Our state-licensed loan model customer has a high propensity to repeat, so higher new customer volumes will create an annuity of repeat volume that will grow as new customer comps remain favorable. Additionally, synergy between our loan and lease businesses through customer cross-marketing and the sharing of back-office risk marketing and finance resources is a natural advantage that FlexShopper has versus a monoline lending business. I am pleased with the initial momentum our new team is bringing to this business, and I'm hopeful that they will bring continued revenue and profitability growth for our loan channel. The combined result of the growth strategies underway produced a material increase in Adjusted EBITDA, which expanded from $8.4 million for Q3 of 2023 to $12.2 million for Q3 of 2024. As a percentage of total revenue, our Adjusted EBITDA margin was 31.5% compared to 26.7% for the same period last year.

In addition to the improvements in bad debt and lease depreciation as a percentage of revenue, salaries and operating expenses, excluding marketing, as a percentage of revenue improved by approximately 130 basis points. Additionally, marketing and loan origination costs and fees as a percentage of revenue improved by approximately 280 basis points. Our strategic plan remains in place, which is to continue to grow our lease and loan business with favorable asset performance that we are seeing and expand the online retail opportunities that are in front of us. We are achieving year-over-year and quarterly sequential revenue growth. We are seeing improved asset quality with lower bad debt. We are increasing product margin, which has a material benefit to our income statement. We are gaining leverage on our marketing and operating expenses.

The result of these strategies has produced significant year-over-year EBITDA growth and positive net income during the third quarter. We will remain vigilant in regards to signs of any potential future economic slowdown when we continue to see customer interest in shopping within our channels, with continued job growth and low unemployment rates, as well as stabilizing consumer prices. I want to thank our team for the hard work and results. We look forward to what we can achieve in 2024 and believe we are well-positioned for continued growth and improved profitability in 2025 and beyond. With that, let me turn the call back over to Russ to review the rights offering in more detail.

Speaker 1

Thanks, JD. Our record third-quarter revenue and Adjusted EBITDA demonstrate the success of the growth strategies underway. As we have positioned the business for sustainable growth and profitability, we have simultaneously been pursuing actions that are intended to simplify and improve our capital structure and ultimately increase net income and earnings per common share. Agreeing on a favorable purchase price to redeem 91% of our Series 2 Preferred Stock at a 50%-plus discount to its liquidation value has the added effect of negating the weighted average Anti-dilution Provision for the vast majority of the preferred stock and is a fundamental catalyst to raise equity capital accretively as we reduce interest and dividend expense.

In addition, as I mentioned earlier, assuming our enterprise value stays constant, redeeming the preferred stock at a 50% discount has the potential to add approximately $1 per share to our enterprise value based on our current share count. Therefore, on October 28, 2024, we filed an S-1 registration statement with the SEC for a proposed rights offering. When the S-1 becomes effective, we plan to launch a rights offering to purchase up to 35 million units, in which each shareholder, as of the record date, receives two non-transferable rights to purchase units. Each unit consists of one share of common stock and a Series A, B, and C right, which expires 30, 60, and 90 days, respectively, after the initial offering. These short-dated rights permit participants to make additional share purchases after learning the impact on balance sheet improvements from the proceeds of the initial raise.

We believe raising capital through a rights offering is in the best interest of shareholders because it allows existing investors the opportunity to maintain their level of ownership in the company. In fact, holders who fully exercise their basic subscription rights will be entitled to oversubscribe for an additional number of units, if available, that are not purchased by other stockholders, subject to pro-rata allocation based on the oversubscription request. We intend to allocate the proceeds of the offering to actions that will produce the largest reduction to our cost of capital. I know that equity raises are often viewed negatively at face value. However, in this instance, as I mentioned previously, this transaction has a clear use of proceeds that we believe will be accretive to investors. In fact, the more shares sold, the more accretive the offering is.

Of course, the higher the offering price, the more accretive the transaction is for all shareholders. In the free writing prospectus filed with the SEC on October 29, we estimate that for every $25 million in net proceeds raised by the offering, we will increase net income by $4.5 million. Looking at the accretive nature of the rights offering another way, and assuming we raise $50 million of net proceeds, we have the flexibility to pay off the $10.9 million balance of our subordinated notes, which will save us $2 million in annual interest expense, redeem 91% of our Series 2 Preferred Stock, which will reduce associated dividends by $4.4 million per year, and use the remaining capital to pay down a portion of our credit facility agreement, which will add an additional $2.6 million in annual interest savings.

We estimate these actions combined will increase annual net income to common shareholders by approximately $9 million and increase earnings for common share. Simplifying and equitizing our capital structure while reducing interest or dividend expense allows us to allocate earnings back into our business, fund more of our growth internally, and produce a higher return on equity. Our third-quarter performance demonstrates we are pursuing this rights offering from a position of strength, and members of FlexShopper's management team and board of directors plan to participate in the offering. I look forward to completing the rights offering in the coming months and updating our investors on FlexShopper's continued success through upcoming press releases and on our next call. This completes our prepared remarks. Operator, please open the call for questions.

Speaker 0

Thank you. Ladies and gentlemen, we will now begin the question and answer session. If you would like to ask a question, please press star and 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star and 2 if you'd 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. Ladies and gentlemen, we will wait for a moment while we poll for questions. The first question comes from the line of Scott Buck from H.C. Wainwright. Please go ahead.

Speaker 4

Hi, good morning, guys. Congrats on the results, and thanks for taking my questions. I wanted to ask you about the improvement in payment performance. How much of that is driven by improved underwriting versus quality of the borrower versus improvements in account servicing? Just trying to kind of piece all that together and see if there's maybe even some more room there for improvement.

Speaker 2

Sure, yeah. This is JD. So I think if I had to rank order, the first one is improved underwriting and fraud evaluation. So we've invested a lot in our risk and analytics team and have done a lot to really make a lot of headway in that kind of efforts. I think the second one is going to be on the quality of the customer. So in our marketing, we actually have a lot of algorithms that look for ideal customers. And as a part of that, we've actually seen a bit of a mix upwards in the way that we evaluate credit. I think another contributor to that is as companies above us are pulling back, their bottom customers are now not getting approved by that credit provider above us and are coming down to us to take those offers.

We're also seeing a bit of a tailwind when it comes to the quality. I think third, but not too far behind, is our servicing capabilities. One big initiative for 2025 is actually to introduce a lot of AI-driven automation in collector servicing capabilities, both through first-party as well as some of our third-party partners. As that gets deployed and as the right offer is presented to the right customer at the right time through the right channel, there will be tailwind, which is going to be a bit of an initiative for us in 2025.

Speaker 4

Great. I appreciate that color, JD. And then on the B2B business, can you remind us how long it takes to get some of these new locations kind of up to speed? And I can't remember. Is there an 80% principle here where 20% of the locations are generating 80% of the leases, or is it significantly different than that?

Speaker 1

No, you're right. I mean, I think what we have, I mean, it's not quite 80/20, but certainly that those top few deciles certainly are responsible for the majority. And on the other side, the bottom decile or two doesn't contribute a whole lot. But much like in our underwriting process, right, we work off of the entire vintage. And so as we're thinking about that entire segment and how it comes together, we've noticed certainly by segment, there's some discrepancies. But when it comes down to automotive versus other, we tend to find that everyone sort of reverts to a similar mean. So I'm hopeful that as we continue to stay in the automotive sector, that we'll continue to see similar progress. And so adding this many stores will result in pretty significant gains on the B2B side. In terms of rollout time, that's always an issue.

When you factor in seasonality and upcoming holidays, it always tends to slow down retailers a little bit. On one hand, you have that top portion that really wants to drive growth. We'll really embrace it during the holidays, and so we'll get some significant lift. The ones that are slower to embrace will probably end up more sort of in that early part of next year before they really start to embrace the product. We'd like to think that in that six to nine-month time frame, we've, outside of improvements to process, right, maybe integrating more directly or making some other modifications, when it comes to just the efforts within the stores and what the teams are able to do in those stores, we find that you've started to plateau, store count being constant, you've started to plateau within six to nine months.

So there is definitely a lead time, maybe compounded by the upcoming holidays. But like I said, it's really based upon how the individual store managers, team leaders, etc., embrace it.

Speaker 4

Yeah, I can appreciate that. Thanks. And then last one for me. Just curious, given kind of seasonality and the holidays coming up, whether we should expect to see a bit of a revenue mix shift between the three verticals. Should we see a higher retail component here in the fourth quarter?

Speaker 1

As having followed us for a while, you know that the fourth quarter is a big one for us. Certainly, that flexshopper.com retail component definitely grows a good bit. But it's also important to remember from a revenue perspective that a lot of these originations will take place in that Thanksgiving to Christmas time frame and won't be fully represented in the fourth quarter. We usually think that you'll see the marketing spend, you'll see the origination counts, you'll see all of that take place in the fourth quarter, but it doesn't really show itself until the first quarter of the next year.

Speaker 4

Yep. No, that makes sense. Well, I appreciate it, guys. Thanks for the time, and congrats again on the results.

Speaker 1

Thanks.

Speaker 2

Thanks.

Speaker 0

Thank you. The next question comes from the line of Michael Diana from Maxim Group. Please go ahead.

Speaker 6

Okay. Thank you. So you've all been extremely busy in the great quarter. I want to go back to the credit quality, and I think that was the main reason for the gross margin improvement up to 58%. Is that sort of a new benchmark for you, do you think? It seems like some of the improvement has had such a material effect. Probably you won't receive that sort of kick going forward. Is that right or wrong?

Speaker 2

Yeah. And I think when we look at how earnings increase over time from here, I think our goal is kind of getting the per-account profitability levels to kind of where it is today, at least on the bad debt side. We don't really anticipate bad debt continuing to drop significantly from here. We do see more and more contribution from our retail margin, which shows up as better depreciation as a percentage of lease revenue as more products are added to our marketplace. But then really the big thing is growing the top line. So the IRRs that we get with this kind of customer is very good. So you get to the place where if you continue to try to decrease bad debt through tightening, then you actually restrict the ability to grow.

Now, having said that, are we saying that we've done everything we can do on the bad debt side? The answer is no. We will have, as I was mentioning earlier, more AI-driven capabilities on our servicing site, which will have a natural benefit to the bad debt levels, and then our risk analytics team continues to work very hard every day to try to gain more benefit out of the existing book, and hopefully, we actually continue to see more of a mix shift upward as whatever soft landing or however you would describe how the economy evolves from here will produce more customers that are more liquidity constrained than they are today, so going forward, we don't plan for a lower bad debt level, but certainly kind of where it is, we have some initiatives that hopefully will keep any potential upward pressure bedded down.

Speaker 1

I think adding on to that, I think the one piece that thinking at the gross profit level, I think the next puzzle we need to solve, Mike, is that there is, as we've talked about numerous times, there's a good number of people coming to our site that are spending time on our site. But when it comes time to check out, they're looking at the different options they have, and they might not think that they are in that credit band that makes sense to choose what we have available on the site.

So what we've been focused on for a while, and it's taken longer than we've expected, is really trying to fill in an option for those consumers that are, we'll say, better credit quality than a traditional lease-to-own consumer, but don't have the liquidity to go purchase, pull out a credit card or debit card, and purchase at their local store or a convenient website, etc., and do need some of the credit options that we hope to soon have on our site. So given how much volume we drive to our website, I think there is a lot of upside if we can solve that piece of an option for the, I don't know, we'll say sort of the low 600 credit score. I think that could be the next big move.

We haven't solved it yet, and we're part of the way into the fourth quarter, but trying to have something in place before we hit December is certainly sort of top of mind. If we can actually catch that last wave right before Christmas, that would be great and provide a lot of data for us. But that's where we're, as we think about continuing to expand gross profit, that's where our target is.

Speaker 2

That margin, yeah, would show up in either a combination of additional retail revenue or a better marketing efficiency, which we've seen some improvement already, but I think this effort that Russ was talking about hopefully will actually add more margin with higher marketing efficiency.

Speaker 6

All right. Thanks, Russ. Thanks, JD.

Speaker 2

Thank you.

Speaker 0

Thank you. The next question comes from the line of Steve Silva from August Research. Please go ahead.

Speaker 5

Thanks, operator. And good morning, and thanks for taking the questions, and congratulations as well on the strong results. I was hoping you could provide some color on the retail pipeline. You guys mentioned in the prepared remarks the strong expansion to date and the fact that you blew past your own internal estimates on the number of locations earlier in the year. I'm just curious as to whether there are any factors you can cite for that acceleration in the pipeline compared to your initial estimates and how you see the breadth of the retail pipeline continuing in 2025.

Speaker 1

Sure, of course. We continue to, so our process, which I'm sure is similar to other companies in our space. There is a lot of work that goes around elephant hunting, so to speak, and you make sure you target a lot of them, make sure you make them the right inroads, and there always seem to be a number of these very large, high door count, high website volume potential retail partners that are out there, but you just don't know when you're going to close them, right? Conversations are continuing, tests are being planned, technology integrations are being worked through, contracts being finalized, but you just don't know when it's going to hit, so for many reasons, we've tended to take the approach that we're going to hit a lot of the singles and sort of have budget internally for that home run once a year.

This is a year where two of the - we had two homers, and that significantly changes our estimates. What is especially intriguing is that we continue to have a lot of these homer opportunities that I said are sort of sitting out there. Sometimes success begets success, I think, as we continue to make more inroads. It becomes easier to close these larger deals. We're excited that the normal one homer a year turned to two this year, and we'll continue to stay at that pace going forward.

Speaker 5

Great. I appreciate the color. And one last one, if I may. Given the return to GAAP profitability this quarter and the expectation that the business remains favorable moving forward, I'm curious as to whether there are any implications for the company's ability to further bring down its debt over time independent of the rights offering, given the fact that the company has a lower capital risk, a lot of the IT investments are already in place. Just curious as to whether there are other uses for the positive income to invest back into the business, or some of that net income could be utilized to bring down debt independent of the rights offering.

Speaker 1

No, that's a good question, Steve. I think the way we would most likely approach, and obviously, it's dependent upon the amount of net proceeds in this rights offering, there is an inflection point at which you have delevered enough that's increased net income enough that you do start to find a way to transition to lower costs of debt capital. And so I guess sort of in a vacuum, it might be a little bit difficult to answer, but I think sort of our instinct would be to lead with, "Let's deliver where we can. Let's continue to focus on growing the business. Let's be thoughtful around finding ways to lower cost of capital." And look, through all of this, it's about making the right IRR decisions and thinking through how that impacts us in the long run.

So, I would think that we have, given that we continue to have a lot of success growing this B2B business, which is not nearly as capital-intensive in terms of headcount, servicing, marketing costs, etc., as the online business, that as you continue to grow that successfully, that you would start to produce capital where you'll be able to sort of take a step back and think, "Are there, do we sort of continue to grow?" I mean, I know you're a little bit newer to the FlexShopper story, but so what we've always said is that the advantage of the direct-to-consumer website is that you can continue to spend marketing dollars and drive people to the site. Obviously, as you spend more, it becomes less efficient. And at some point, while you could continue to grow, it just doesn't make economic sense.

The retailer, the B2B side of that, doesn't have any of those constraints, right? You're plugging into a retailer. The retailer's driving the consumers to you, and you're just hopefully making very good underwriting decisions and moving forward. But we cannot make retailers do business with us as much as we would like to. So it's really about proving to them and growing that business. But like I said, you do get to a point where continuing to spend to grow through flexshopper.com isn't efficient anymore. And of course, at that point, you would certainly make the decision to, rather than grow inefficiently, you would rather go and continue to deliver other ways. But like I said, it's really about exploring all the options, including looking for cheaper, less restrictive forms of debt capital also along the way.

Speaker 5

Okay. I appreciate the extra color, and congratulations again on the quarter.

Speaker 1

Thanks so much. You.

Speaker 0

Thank you. Ladies and gentlemen, this concludes our question and answer session. I would now hand the conference over to Russ Heiser for his closing comments.

Speaker 1

Thank you. We appreciate all the questions today. Thanks for everyone's time, and we look forward to communicating our holiday season results on our next call.

Speaker 0

Thank you. The conference of FlexShopper has now concluded. Thank you for your participation. You may now disconnect your line.