Enova International, Inc. Q2 FY2021 Earnings Call

Good day, and welcome to the Enova International Second Quarter 2021 Earnings Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Lindsay Savarese, Investor Relations. Please go ahead.

Thank you, operator, and good afternoon, everyone. Enova released results for the second quarter of 2021 ended June 30, 2021, this afternoon after the market closed. If you did not receive a copy of our earnings press release, you may obtain it from the Investor Relations section of our website at ir.enova.com. With me on today’s call are David Fisher, Chief Executive Officer; and Steve Cunningham, Chief Financial Officer. This call is being webcast and will be archived on the Investor Relations section of our website. Before I turn the call over to David, I’d like to note that today’s discussion will contain forward-looking statements, and as such, is subject to risks and uncertainties. Actual results may differ materially as a result of various important risk factors, including those discussed in our earnings press release and in our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. Please note that any forward-looking statements that are made on this call are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. In addition to US GAAP reporting, Enova reports certain financial measures that do not conform to generally accepted accounting principles. We believe these non-GAAP measures enhance the understanding of our performance. Reconciliations between these GAAP and non-GAAP measures are included in the tables found in today’s press release. As noted in our earnings release, we have posted supplemental financial information on the IR portion of our website. And with that, I’d like to turn the call over to David.

Good afternoon, everyone. Thanks for joining our call today. I'll give an overview of our second quarter results and then I will discuss our strategy and outlook for the remainder of 2021. After that, I'll turn the call over to Steve Cunningham, our CFO, who will discuss our financial results and outlook in more detail. The second quarter played out just as we expected and as we discussed on our Q1 earnings call. As the economy began to open back up, consumers rapidly increased their spending, demonstrating the pent-up demand that we believed existed. In addition, as predicted, we are finding that small businesses have been beneficiaries of this pent-up consumer demand. Because of these dynamics, we saw a sharp increase in demand across all of our products during the quarter. To capture this increase in demand, we aggressively and quickly ramped up marketing to lean into the strong demand and solid credit quality we observed. One of the real benefits of our online-only model is the ability to rapidly adjust marketing investment based on consumer behavior. For quite some time, we've been trying to increase marketing as a percentage of revenue and are pleased with our ability to do exactly this in Q2. The result was solid originations growth with Q2 originations up 35% sequentially and more than seven times the second quarter of last year when we scaled back originations at the onset of the pandemic. In addition, originations from new customers increased to 39% of total originations, up from 33% in Q1 of 2021 and well above the 7.4% during the pandemic in Q2 of 2020. Given the skillful execution of our team during the last 16 months since the pandemic began, we believe we are continuing to take share in both the SMB and consumer markets with our diversified product offerings and customer-friendly online-only model. Looking forward, while the first part of Q3 tends to be seasonally slow, we are seeing continued strong demand and expect it to accelerate as we approach our seasonally stronger fall. Even with the strong growth in demand and originations, credit quality remained historically good during Q2. We expect credit metrics to trend back to pre-pandemic levels over time. But based on what we are seeing right now, we think that transition will be gradual over the next several quarters. As a result of the origination growth, revenue in the second quarter increased 5% year-over-year and 2% sequentially to $265 million. Benefiting from the strong credit performance, adjusted EBITDA rose 43% year-over-year to $135 million, and adjusted EPS increased from $1.68 in Q2 of last year to $2.26 in Q2 of 2021. In the second quarter, consumer products accounted for 45% of our portfolio and small business products represented 55%. Within consumer, line of credit products represented 35% of the consumer portfolio, installment products accounted for 67%, and short-term loans represented just 3%. We expect a mix between consumer and SMB to fluctuate over time based on both seasonality and macroeconomic factors, and we are pleased with the diversified nature of our portfolio going forward. From an operational perspective, as we mentioned on our last earnings call, the integration of OnDeck is essentially complete. OnDeck's performance continues to exceed our expectations, and we will easily exceed our forecast of $50 million of annual cost synergies, primarily from eliminated duplicative resources, as well as $15 million in run-rate net revenue synergies. We also continue to expect the transaction will be accretive in 2021 and generate EPS accretion of more than 40% in 2022. And as we discussed last quarter, while we originally thought that OnDeck's legacy portfolio would have very little value, we now expect to receive over $220 million of total cash from the acquired portfolio, net of securitization repayments. In fact, we've already realized over $100 million from the legacy portfolio. Turning to our recent acquisition of Pangea, which we closed in mid-March of this year we have gained another product and high-growth business in our portfolio. Since closing, we've been able to leverage our online business expertise and analytics, technology, and marketing capabilities to rapidly accelerate Pangea's growth. While Pangea's results are currently not material to Enova's overall revenues, we believe the market opportunity is vast and we are well-positioned to continue to grow in that space. In summary, we are encouraged by the strong momentum we are seeing. The improving economy, combined with our highly scalable and flexible machine learning technology, provide tailwinds heading into the back half of 2021 and beyond. We are focused on producing sustainable and profitable growth, and now accelerating our growth as the economy recovers. We will continue to lean into demand and help hard-working people across the nation get access to fast, trustworthy credit. Now, I'd like to turn the call over to Steve Cunningham, our CFO, who will discuss our financial results and outlook in more detail. And following Steve's remarks, we'll be happy to answer any questions that you may have.

Thank you, David, and good afternoon, everyone. As David mentioned in his remarks, we continue to be encouraged by our historically strong credit quality and the meaningful increase in originations across our businesses as demand continues to improve. We originated more receivables this quarter than any second quarter in our company's history, ended the second quarter with the largest receivables portfolio in our company's history and continue to deliver near record profits. The ability of our talented team to successfully navigate a challenging operating environment and to smoothly integrate OnDeck over the past year has us well positioned to grow meaningfully from here as we leverage our resilient direct online-only business model, nimble machine learning powered credit risk management capabilities, and solid balance sheet. Now turning to Enova's second quarter results. As you'll note in my comments, our total company and small business results, when compared to the year-ago quarter are heavily influenced by our acquisition of OnDeck last October. As expected, second quarter total company revenue from continuing operations was $265 million, an increase of 2% sequentially and 5% from the second quarter a year ago. Total company combined loan and finance receivables balances on an amortized basis were $1.4 billion at the end of the second quarter, up 12% sequentially and 73% higher than the second quarter a year ago. Total company originations were $681 million, up 35% sequentially and originations from new customers were 39% of total originations, our highest percentage since the third quarter of 2019, as we were able to accelerate our marketing activities and attract a higher proportion of new customer demand as the economy opened up in the second quarter. Small business revenue increased 13% sequentially and was nearly six times higher than the same quarter a year ago. Small business receivables, on an amortized basis, totaled $786 million at June 30, a 12% sequential increase and more than six times higher than the end of the second quarter of 2020, as small business originations increased 24% sequentially to $401 million. Revenue from our consumer businesses decreased 4% sequentially and declined 26% from the second quarter of 2020. Consumer receivables, on an amortized basis, ended the quarter at $640 million, up 12% sequentially and down 9% from the year-ago quarter. Consumer originations for the quarter totaled $280 million, 52% higher sequentially due to seasonality and recovering demand and were more than three times higher than the second quarter of 2020. Year-over-year changes in consumer revenue receivables and originations reflect our pullback in originations with the onset of the COVID pandemic last year. The sequential growth rates for total company and consumer revenue were influenced by accelerating originations growth as we moved through the second quarter, resulting in a larger than normal difference in ending and average receivables balances this quarter. On a total company basis, originations for the month of June were 54% higher than for the month of April, and consumer originations for the month of June were 80% higher than for the month of April. As a result, the sequential growth in average receivables, which are a key driver of revenue growth, lagged the sequential growth in ending receivables. We expect sequential average receivables growth will accelerate in the third quarter from the strong ending receivables position at June 30. As a result of those dynamics, we expect total company revenue for the third quarter of 2021 to increase at a slightly higher rate than the 2% sequential growth in the second quarter. We expect continued growth in revenue over the coming quarters, but are likely to see some quarter-to-quarter variations from the timing, level, and mix of originations from our typical seasonality as well as from the impact on relative demand across our consumer and small business products, as the economic recovery continues. The net revenue margin for the second quarter was 98%, up from 92% in the first quarter and remains elevated as we continue to see strong credit quality, which increases the fair value of the portfolio. As you'll recall, the change in the fair value line item includes two main components during the reporting period: first, net charge-offs and second, changes to the portfolio's fair value resulting from updates to key valuation inputs including future credit loss expectations, prepayment assumptions, and the discount rate. I'll discuss those items in more detail. First, to the second quarter, the total company ratio of net charge-offs, as a percentage of average combined loan and finance receivables, was 2.4%, among the lowest quarterly net charge-off ratios in our company's history. This quarter's net charge-off ratio improved from 4.2% in the first quarter and is significantly below the 15.9% ratio for the second quarter of 2020. Net charge-off ratios for both consumer and small business receivables trended lower sequentially and remained well below year-ago levels. Solid credit performance of our portfolio continues to demonstrate the ability of our sophisticated machine learning credit models to focus on lending to customers who can repay their obligations through economic cycles, as well as the ability of our talented team to find solutions to support customers who are having difficulties. Second, the fair value of the consolidated portfolio as a percentage of principal increased to 103% at June 30 from 101% at March 31, as the outlook for portfolio credit quality remains strong. The improvement this quarter was driven by an increase in the fair value of the small business portfolio as a percentage of principal, as credit metrics and modeling at the end of the second quarter reflect an improving outlook for the expected future credit performance of our small business receivables. The fair value of the consumer portfolio as a percentage of principal declined this quarter from a historical high last quarter and continues to reflect a solid outlook for credit quality. The change was driven primarily by the strong sequential growth in consumer originations, especially from new customers. Sequential decline in delinquent receivables as a percentage of loan and finance receivables balances at the end of the quarter also reflects strong customer payment rates and the continued solid credit profile of the portfolio. The percentage of total portfolio receivables past due 30 days or more was 5.7% at June 30, compared to 7.6% at the end of the first quarter and 4.5% at the end of the second quarter a year ago. The percentage of small business receivables past due 30 days or more declined during the quarter from 10.2% at March 31 to 7.1% at June 30. The decline was driven by continued improvement in delinquency levels across all of our small business brands. Percentage of consumer receivables past due 30 days or more was 4.1% at June 30 compared to 4.3% at March 31 and 4.4% at the end of the second quarter a year ago. With the continued improvement in the economic environment, we lowered the discount rates used in our fair value calculations by another 100 basis points this quarter. With the change this quarter through the first half of 2021, we've lowered the discount rates used in our fair value calculations by 200 basis points or about 40% of the increase in the discount rates that we initiated in the first quarter of 2020 to capture the uncertainty of the operating environment. As the economic recovery continues to gain momentum, we expect continued reductions in the discount rates used in our fair value calculations over the coming quarters, as well as reversals of downward adjustments that we maintained in our fair value calculations over the past year to reflect the impact of near-term economic uncertainty on the risk of higher-than-expected consumer defaults. To summarize, the change in fair value line item is benefiting from low levels of net charge-offs and an increase to the fair value of the total company portfolio as credit metrics and modeling at the end of the second quarter reflect a solid outlook for expected future credit performance. Looking ahead, we expect the net revenue margin for the third quarter of 2021 to range between 65% and 75%. As the economy recovers and demand and originations continue to rise, the net revenue margin should normalize over several quarters at around 50% to 60% as newer and less seasoned loans become an increasingly larger proportion of the portfolio. Our third quarter net revenue margin expectations and the degree and timing of future normalization in the ratio will depend upon the timing, speed, and mix of originations growth. Now turning to expenses. Total operating expenses for the second quarter including marketing were $129 million or 49% of revenue, compared to $108 million or 42% of revenue last quarter and $42 million or 17% of revenue in the second quarter of 2020. Marketing expenses increased to $55 million or 21% of revenue in the second quarter from $29 million or 11% of revenue last quarter and from $3 million or 1% of revenue in the second quarter of 2020, as we met rising customer demand to meaningfully increase originations this quarter with an increasing proportion from new customers. With the strong unit economics we are seeing from new originations and the expected increase in demand through the rest of the year as the economic recovery continues, we expect marketing spend in the near-term will likely range in the upper teens as a percentage of revenue depending on the level of originations. Operations and technology expenses for the second quarter totaled $35 million or 13% of revenue compared to $36 million or 14% of revenue last quarter and $17 million or 7% of revenue in the second quarter of 2020. O&T costs were relatively flat sequentially, as variable spending increases from rising originations and receivables this quarter were offset by reductions in non-variable personnel expenses. Given the significant variable component of this expense category, sequential increases in O&T costs should be expected in an environment where originations are accelerating and receivables are growing. General and administrative expenses for the second quarter totaled $39 million or 15% of revenue compared to $44 million or 17% of revenue last quarter and $22 million or 9% of revenue in the second quarter of 2020. As expected, excluding one-time nonrecurring expenses related to the OnDeck acquisition, G&A expenses declined sequentially. Year-over-year increases in G&A costs were driven by the addition of OnDeck G&A-related expenses. Looking ahead excluding any one-time items, we expect G&A spend to remain relatively flat for the remainder of 2021 and it should decline as a percentage of revenue as these expenses scale with increases in originations and receivables. Adjusted EBITDA, a non-GAAP measure decreased 2% sequentially and increased 43% from a year ago to $135 million in the second quarter for the reasons I previously discussed. Our adjusted EBITDA margin for the quarter was 51% compared to 53% last quarter and 37% in the second quarter of 2020. Adjusted EBITDA margin should normalize for the remainder of 2021 as a result of continued marketing investments and the aforementioned growth-related normalization in net revenue margins and volume-related expenses. As previously noted, the degree and timing of any normalization will depend upon the timing, speed, and originations growth and will likely occur over several quarters as originations return to historical levels. Our stock-based compensation expense was $5.3 million in the second quarter, which compares to $3.7 million in the second quarter of 2020. The increase is related to the OnDeck acquisition and as I've described in recent quarters the expense associated with the 2017 increase in the vesting period for restricted stock units is now fully reflected in year-over-year comparisons. Normalized stock-based compensation expense should approximate $5 million per quarter going forward. Our effective tax rate was 22% in the second quarter, which declined from 27% for the second quarter of 2020. The decline from a year ago was driven primarily from the increase in operating income relative to typical nondeductible expenses. We expect our normalized effective tax rate to remain in the mid- to upper 20% range. We recognized net income from continuing operations of $80 million or $2.10 per diluted share in the second quarter compared to $48 million or $1.58 per diluted share in the second quarter of 2020. Adjusted earnings, a non-GAAP measure increased to $86 million or $2.26 per diluted share from $51 million or $1.68 per diluted share in the second quarter of the prior year. The trailing 12-month return on average shareholder equity using adjusted earnings was 42% during the quarter compared to 29% a year ago. We ended the second quarter with $467 million of cash and marketable securities including $394 million in unrestricted cash and had an additional $534 million of available capacity on $916 million of domestic committed facilities. Our debt balance at the end of the quarter includes $381 million outstanding under committed facilities. Our cost of funds for the second quarter was 7.8% versus 8.6% for the first quarter of 2021 and 8% a year ago. The decline in our cost of funds reflects the impact of recent transactions completed since the end of the first quarter. Based on current market rates our domestic marginal cost of funds ranges from 2% to 5% depending on the facility utilized. Our solid balance sheet and ample liquidity have us well-positioned to support originations and receivables growth as the economy recovers. Due to the ongoing uncertainty in the economy, we are not providing detailed financial guidance at this time. However, as we return to meaningful growth in originations and receivables, we expect to invest more in marketing by leveraging our machine learning driven analytics to capture increased demand at attractive unit economics. As I've mentioned in my remarks today this should lead to some normalization in the net revenue margin, growth-related variable expenses and the adjusted EBITDA margin from recent levels. The degree and timing of any normalization will depend upon the timing, speed and mix of originations growth and will likely occur over several quarters as originations begin to return to or exceed pre-COVID levels. We remain confident in our ability to deliver meaningful and consistent top and bottom line growth as we leverage the benefits of the scale and efficiency of our direct online-only operating model, our broad and diversified consumer and small business product offerings, our machine learning powered credit risk management capabilities and our solid balance sheet. And with that, we'd be happy to take your questions.

We will now begin the question-and-answer session. And the first question comes from David Scharf with JMP Securities. Please go ahead.

Great, good afternoon, and thanks for taking my questions. Terrific commentary on the increase in demand. And I'm wondering, if you can maybe given all the variables that are still unknown and how this pandemic proceeds, certainly understand not having guidance at this point. But I'm wondering, in terms of when we would expect demand to fully normalize, it looked like your originations in the quarter were still 40% below the second quarter of 2019. This is for consumer loans. But you had mentioned that the June volumes were considerably higher than April and May. I'm wondering if you were to quarterize the June volumes, can you give us a little more sense for how we exited the quarter relative to two years ago, and whether your expectation, based on the child tax credit and everything else we know, whether you're expecting the back half of the year to be pretty close to the back half of 2019 in terms of consumer originations?

We experienced a significant increase in performance during the quarter, with June being much stronger than April, while May served as a transitional month. We ended the quarter at a much higher run rate compared to the average for that period, consistent with the commentary about average versus ending metrics. Making forecasts for the remainder of the year is challenging due to uncertainties surrounding COVID and its impact on the economy's trajectory. However, given the momentum we observed in Q2 and what we're seeing so far in Q3, there is reason to be optimistic that consumer demand will recover to pre-pandemic levels as the situation improves. Predicting this remains difficult because of the unpredictable nature of the pandemic. Additionally, the child tax credit presents a timing issue rather than a fundamental change in consumer demand. It may lessen the seasonal effects of tax return season next year, potentially reducing demand slightly through the rest of 2021, but we anticipate higher demand during the early part of 2022. A reduction in seasonality can actually benefit our operations and help us manage the business more effectively, so overall, this shouldn't negatively impact demand in the long run.

Got it. No, it's helpful. And maybe just one follow-up on the demand side. With respect to the new borrowers you're bringing onboard, I guess it was 39% of originations.

Yes.

Is there anything different in the profile of that consumer versus 2019 whether it's your internal scoring the company....

Nothing particularly obvious. The state mix is a little different. The states that have opened up more we're seeing more demand earlier and that's been true for months now so that's not surprising. And so as the economy continues to open it's the states that have opened up slower where most of the additional demand is coming; it's not even across the board. So that's really the primary difference. Other than that, nothing significant. It's the same customers. It really is it's the same customers that we had, same types of customers we had pre-pandemic or the same types of customers that are coming back post-pandemic.

Got it. Great. Thank you very much.

Yes, thanks David.

The next question comes from John Hecht with Jefferies. Please go ahead.

Afternoon. Congrats on a great quarter. Thanks for taking my questions as well. So as you guys have sort of seasoned into the OnDeck book, I'm wondering can you maybe describe to us how the kind of customer acquisition channel is different between the consumer segments and the small business segments? And over time will those differences migrate at all from what you've learned so far?

Sure. So I think the primary difference is, on the consumer side we have kind of leads and then direct stuff that we go out and control whether it's TV direct mail or digital. And on the small business side, you have their partner channel also known as iSOS and then you have direct. Historically Enova, if you go back five to eight years ago, was very much lead-driven. So all of the large majority of our consumer business came from lead providers. And kind of starting five to eight years ago, kind of around the time I started, we've made a big push into controlling more of our own destiny by doing a lot more direct marketing activities. And now it's completely flip-flop. We have a large majority of our business on the consumer side is direct. That similar dynamic is we think is what will happen on the small business side. The good news about OnDeck at least they had a direct channel and a pretty good direct channel because of their terrific brand on the small business side where our small business products had no direct channel; it was all through iSOS. So, we gain that capability through OnDeck. And certainly, by leveraging the brand plus our marketing capabilities that we developed on the consumer side through the direct channels we certainly expect to increase the proportion of our small business loans that come through the direct channel over time.

Okay, that's great. I have a question regarding the pace of recovery and demand in the small business sector compared to the consumer sector. Do you think they will follow different paths? Additionally, do you have any insights on the normalization of credit quality at this time?

Sure. We believe that demand will follow a similar trajectory. We didn't restate what we mentioned in our Q1 and Q4 calls, but we noted that as the economy reopens, consumers will begin to spend again, particularly at small businesses. During the pandemic, they continued to shop at large retailers like Costco and Walmart while maintaining their regular bills. However, they reduced spending at smaller shops, such as boutiques or local bars and restaurants. As we entered June, with the economy starting to open and the weather improving across the northern U.S., we observed consumers returning to small businesses, which benefited greatly from this shift. Small businesses seemed to prepare for this earlier than expected, looking to restock and hire new employees in anticipation of increased consumer activity, which started happening as vaccination rates rose and restrictions eased. The timing might vary by a month or two, but overall, the trends are closely aligned. Meanwhile, on the credit side, we've noticed strong credit performance even with a significant influx of new customers. Over time, we believe that credit quality will revert to historical levels, and it would be surprising if the trends between consumers and small businesses diverged significantly. While there may be some seasonal fluctuations as we approach Q1 of 2022, we expect the overall patterns to remain consistent.

Wonderful. Thanks guys very much.

Yep. Thanks, John.

It seems we have no further questions. I will now turn it over to David Fisher for any closing remarks.

Great. Thanks everybody for joining our call today. We look forward to speaking with you again next quarter. Have a great evening.

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