PROG Holdings, Inc. Q2 FY2023 Earnings Call

Thank you, and good morning, everyone. Welcome to the PROG Holdings second quarter 2023 earnings call. Joining me this morning are Steve Michaels, PROG Holdings' President and Chief Executive Officer; and Brian Garner, our Chief Financial Officer. Many of you have already seen a copy of our earnings release issued this morning, which is available on our Investor Relations website. During this call, certain statements we make will be forward looking, including comments regarding our GMV performance and lease merchandise write-offs in future periods, shareholder return over time, our updated 2023 full year outlook and our outlook for the third quarter of 2023. I want to call your attention to our safe harbor provision for forward-looking statements that can be found at the end of the earnings press release that we issued earlier this morning. That safe harbor provision identifies risks that may cause actual results to differ materially from the expectations discussed in our forward-looking statements. There are additional risks that can be found in our annual report on Form 10-K for the year ended December 31, 2022, which we encourage you to read. Listeners are cautioned not to place undue emphasis on forward-looking statements we make today, and we undertake no obligation to update any such statements. On today's call, we will be referring to certain non-GAAP financial measures, including adjusted EBITDA and non-GAAP EPS, which have been adjusted for certain items which may affect the comparability of our performance with other companies. These non-GAAP measures are detailed in the reconciliation tables included with our earnings release. The company believes that these non-GAAP financial measures provide meaningful insight into the company's operational performance and cash flows and provides these measures to investors to help facilitate comparisons of operating results with prior periods and to assist them in understanding the company's ongoing operational performance.

Thank you, John, and good morning, everyone. I appreciate you being with us today as we discuss our second quarter results, share our thoughts on a few important Q3 metrics and provide an update on our full year 2023 financial outlook. We had another excellent quarter with Q2 GMV slightly beating our expectations, net revenues above the high end of our expectations and adjusted EBITDA well above the range we provided at the end of April. I'm proud of our team's performance as they executed at a high level in what remains a challenging retail environment. The trend of fewer customers choosing to utilize 90-day buyout options and the strong portfolio performance that we discussed in Q1 continued into the second quarter. As you may have seen in this morning's earnings release, we are incorporating our year-to-date outperformance and reflecting these favorable trends in our increased outlook for 2023. The strong customer payment behavior we experienced in Q2 as evidenced by our year-over-year 260 basis point gross margin expansion, improved write-offs of 7.1% and adjusted EBITDA growth of $22.8 million or 43.7% resulting in a 12.7% margin. Our write-offs for the first half of 2023 were 6.5%, keeping us on track to deliver another year within our targeted annual range of 6% to 8%. The decline in GMV was largely due to our implementation of tighter decisioning in Q2 last year, which we believe accounted for approximately two-thirds of our GMV decline. As we look to July trends and our Q3 expectations, we anticipate the difficult year-over-year GMV comparisons to ease as we fully lap the introduction of last year's tighter decision. We have yet to see any indicators leading us to assume that retail sales will materially rebound through the balance of 2023. Though we have not assumed any benefit in the revised outlook we provided this morning, we believe that the current macro environment will result in tightening of lending practices from credit providers above us in the STACK. Additionally, past experience demonstrates that consumers benefit from our flexible payment options during periods of sustained liquidity pressures. Our teams are working well with their counterparts at our retail partners to find GMV growth opportunities, including promotions, point-of-sale materials and tech integrations that improve application flows and conversion rates. We are on track to grow our balance of share with several large retail partners in the second half of this year through new e-commerce integrations. Our three-pillared strategy to grow, enhance and expand remains focused on sustainable growth rather than short-term gains. PROG emphasizes dedication to our business development efforts. In a sluggish retail climate, our goal is to broaden new and existing retail partnerships, positioning ourselves for significant growth once conditions improve. We remain focused on regaining growth through sustainable strategies, including e-commerce, marketing and technology innovations, along with new retailer pipeline conversion. Our efforts to increase our e-commerce business are showing solid progress. We added nearly four times the number of new partners in the first half of 2023 than we did in the same period last year, and the channel consistently contributes more than 15% of our total GMV. These new partners, along with upcoming e-commerce integrations with several existing retailers should contribute to our long-term GMV growth. We are also planning second half promotions and cross-marketing with many of our key retailers in support of GMV. One specific example of this is last week's PROG Perks Week, where we provide daily offers from select retail partners to our large database of current and previous customers. We have run this promotion several times over the last two years with much success, and retail partners have enjoyed the incremental business the program drives. This is just one example of the benefit of being part of the PROG Preferred Partner Network. Our high customer retention, illustrated by consistent repeat rates of over 50% is a testament to our customers' affinity for our leasing products and contributes to our higher than average lifetime value to customer acquisition cost ratio. Lastly, our pursuit of new retail opportunities remains a key component of our strategy for long-term growth, especially in the current challenging retail environment that may motivate more retailers to seek avenues for revenue enhancement. We have added a number of regional accounts in the quarter and remain in ongoing discussions with many recognizable regional and national brands about the value Progressive Leasing can bring to their business and customers. We're confident in our proven ability to increase share balance with existing retailers while converting retailers without a virtual lease-to-own payment option, and we'll continue to build the relationships and technologies that will enable us to capture more of our industry's $30 billion to $40 billion addressable market. Under ENHANCE, our technology initiatives aimed at improving the retailer experience and offering customers a more frictionless omnichannel journey are progressing nicely. And we believe those initiatives will bolster our GMV performance in future periods. Our tech roadmap is focused on three core areas: improving our customer-centric flexible lease platform, providing self-service tools to enable a superior retailer experience while helping the customer make the best and most informed choices and offering greater personalization for a streamlined shopping and decisioning experience. We are also developing products that we believe will boost our direct-to-consumer business and give retail partners an easier path to identify and convert potential lease-to-own customers. We aim to enhance operating efficiency while addressing technical debt, an issue common in today's rapidly evolving technology landscape. Lastly, our PROG Labs R&D group is innovating ways to enhance customer service, personalization and decisioning through generative AI. As for expand, in Q2, we announced a new product called Bill, a credit management tool designed to aid consumers in enhancing their credit scores. Our leasing customers frequently express a desire to improve their credit profile. Bild, which is a blend of an installment loan and a secured savings account, both issued by WebBank, can help to address this need while aiding in credit history and savings accumulation. Bill is a natural addition to our product suite, joining Progressive Leasing, Vivad 4 as inclusive and transparent financial products for consumers. In addition to empowering our customers through their financial journey, we anticipate Bill will boost progressive leasing and Vivad volumes catering to potential customers currently not qualifying for leases or loans. These pillars are underpinned by our robust financial health, marked by strong profitability, substantial free cash flow and a healthy net leverage position, all of which we expect to continue going forward. This financial strength enables us to invest in areas promoting future growth. Turning to capital allocation; we have acquired over 2.5 million shares of our outstanding common stock in the first six months of the year at an average price of $28.26 per share. These purchases account for approximately 5% of our outstanding shares. Since the company spin transaction 2.5 years ago, we have reduced our share count by roughly one-third. Year-to-date, we have generated $205 million of cash flow from operations, closing the quarter with a cash balance of $253 million. As a reminder, we typically generate the majority, if not all, of our operating cash flow in the first half of the calendar year, a seasonal pattern we expect again in 2023. Our capital allocation priorities remain unchanged, and we expect to fund growth, look for strategic M&A opportunities and return excess cash to shareholders primarily through share repurchases. While Brian will provide more detail on the upward division to our outlook for the year, I'd like to provide some high-level thoughts. Our first half earnings outperformed expectations due to tailwinds that may not carry forward into the remainder of the year with the same magnitude. Our updated outlook reflects ongoing challenges to consumer demand resulting from the macro environment. We expect that revenues in the second half of 2023 will show a mid- to high single-digit percentage decline as compared to the same period last year, primarily due to GMV performance in the first half of the year, resulting in a smaller lease portfolio balance. However, there is an easing in a difficult year-over-year GMV comparison as we lap last year's decisioning changes. My summary is consistent with last quarter. Our strong first half far exceeded earnings expectations and as a result of the hard work of our teams and strong customer payment behavior. We have a proven track record of navigating through dynamic and challenging environments, and we will adjust as macro conditions evolve. We believe our strong financial health and ongoing investments will drive compelling shareholder return over time. I'll now turn the call over to our CFO, Brian Garner, for more details on our second quarter results and 2023 outlook.

Thanks, Steve. Let me start by summarizing our Q2 highlights. For the second consecutive quarter, we surpassed earnings expectations by effectively managing our P&L in a highly uncertain environment. I appreciate the teams for their dedication in maintaining portfolio health and SG&A expenditures in a challenging retail environment, as well as for pursuing sustainable long-term growth opportunities. During the quarter, customer payment behavior remained robust, leading to increased gross margins thanks to elevated portfolio yields. Like in Q1, we noticed fewer customers opting for 90-day purchase options, but our write-offs stayed within our targeted annual range. We are continually managing portfolio performance as consumer behavior and lease outcomes fluctuate. Q2 consolidated revenue fell 8.7% year-over-year due to a lower portfolio balance at the start of the period; however, revenue outperformed expectations, driven by strong portfolio performance. Consolidated adjusted EBITDA rose 43.7% to $75 million from $52.2 million in Q2 last year. The better-than-expected consolidated adjusted EBITDA results were mainly due to our Progressive Leasing segments, decreased SG&A, reduced write-offs, and enhanced gross margins, supported by our focus on operational efficiencies. Non-GAAP diluted EPS increased to $0.92 per share, a growth of 76.9% from $0.52 per share in Q2 of 2022. We continue to showcase the resilience of our business model and our ability to adapt to revenue challenges while maintaining margins and cash flow, and I’m very proud of our team's efforts in achieving these results. In our Progressive Leasing segment, GMV decreased 14.7% year-over-year, slightly better than our internal expectations. We improved the year-over-year GMV comparison from a 17% decline in Q1 to a 14.7% decline in Q2 and anticipate a mid-single-digit decline for Q3. As Steve mentioned, we believe that roughly two-thirds of the negative GMV comparison in the first half stems from proactive measures we implemented to tighten our decisioning in Q2 of 2022, which in turn has enhanced our write-offs and profitability. Q2 revenue fell 8.9% due to a reduced gross leased asset balance during the quarter, which ended down 10.7% year-over-year, along with a decline in 90-day buyouts, partially offset by improved portfolio yield. Nonetheless, similar to last quarter, year-over-year gross margin in Q2 improved by 260 basis points to 33%, mainly driven by strong customer payment behavior and lower levels of 90-day buyouts, as fewer customers opted for the early buyout option. These lower buyout numbers during the first half of the year resulted in higher margin outcomes in Q2, and our write-offs remained within acceptable levels. Our updated outlook suggests that 90-day buyout activity and write-offs will return to pre-pandemic seasonal trends for the remainder of 2023, which will lead to a slight decrease in gross margins compared to the first half of the year. For our lease's SG&A expense in Q2 was $78.3 million, down $3.6 million or 4.4% from $81.9 million in the same quarter last year. SG&A as a percentage of revenue slightly increased to 13.6% from 13% in Q2 of 2022. We expect that SG&A as a percentage of revenues will be higher for the remainder of the year compared to the first half of 2023. We will continue to operate efficiently amidst a challenging consumer demand environment while balancing investments in key technology platforms, marketing, and business development. Progressive Leasing's write-offs were $41 million or 7.1%, down from 9.8% in the same period last year. The sequential quarterly rise in write-offs during the first half of 2023 was due to seasonal trends, accumulating year-to-date write-offs of 6.5%. We remain on track to conclude the year within our targeted annual write-off range of 6% to 8%. Moving to our balance sheet, we finished the quarter with $253 million in cash and gross debt of $600 million, resulting in a net leverage ratio of 1.14 times our trailing 12-month adjusted EBITDA of $304.1 million. In the second quarter, we repurchased 1.1 million shares of our common stock at a weighted average price of $32.65 per share, and we have $265.4 million remaining under our previously authorized $1 billion share repurchase program. To summarize our outperformance against expectations in the first half of 2023, we actively managed the portfolio return while driving efficiencies in our cost structure, noticing that fewer customers chose to use 90-day buyout options led to higher gross margins. I would like to discuss a few important aspects of our Q3 and revised full-year outlook, which was shared in this morning's earnings press release. As a reminder, the guidance from our Q1 earnings call in late April assumed GMV headwinds, with easing expected in year-over-year comparisons starting in July. The gross leased asset balance, a significant determinant of future revenue, was predicted to decline further at the end of Q2. Although we anticipated margin pressures as the year progressed, we believed our lease portfolio performance and low 90-day buyout rates would enhance Progressive Leasing margins year-over-year. We projected a decrease in 90-day buyout activity year-over-year for the remainder of 2023, with expectations that the variance would narrow compared to Q1 as the year unfolded. Our second-quarter performance gives us cause to believe that GMV is trending slightly better than we expected in April. Coupled with our strong year-to-date performance, we have greater confidence in our portfolio performance moving forward. Lastly, even though SG&A as a percentage of revenue will rise through the rest of the year, we will assess the timing and return of our investments to align with revenue trends and future growth opportunities. As a result, we are raising our full-year revenue and earnings outlook. We expect the Q3 GMV year-over-year comparison to ease to a mid-single-digit decline as we contend with last year’s tightening. Our updated consolidated outlook for 2023 includes revenues ranging from $2.36 billion to $2.39 billion, adjusted EBITDA between $270 million and $280 million, and non-GAAP EPS between $3.10 and $3.25. This outlook assumes continued soft demand for leasable consumer durable goods, no significant changes in the company's decision-making approach, an effective tax rate for non-GAAP EPS of approximately 27%, and no impact from additional share repurchases. Consistent with last quarter, our base case outlook for the remainder of the year takes current consumer trends into consideration but does not factor in further economic downturns, a material adverse effect on our customers' employment, or substantial benefits from tightening by providers in our credit stack.

Thanks for having me on taking my questions. Just curious your thoughts on kind of the health of your underlying consumer. Obviously, some moving parts in terms of less early buyout activity, but ongoing stable credit performance, obviously, the employment environment is very strong still. But just kind of get a sense for the overall health of the underlying consumer and potentially, if there are any sort of green shoots of improving demand or consumer confidence there?

Thanks, Kyle. I'll start by saying that last quarter we discussed the decrease in consumers opting for the 90-day buyout option and the effect on our overall margins. We were trying to evaluate how those consumer groups would progress and how those who typically would have chosen the buyout during tax season would perform instead. Thus far in Q2, they are performing quite well; they are making their payments, and active leases are still in place. This bodes well for consumer health. You mentioned strong employment, which is always a significant factor for us, and we're not witnessing any signs of weakness in the employment sector or the economy. Additionally, with cost pressures and inflation showing some signs of easing, that adds a positive outlook. Our portfolio performance reflects this, as indicated in our previous remarks about strong portfolio metrics and excellent customer payment behaviors. The primary uncertainty lies in the evolving situation regarding student loan repayments coming this fall, which presents various implications for who may be affected and what may transpire leading up to that. Overall, the consumer outlook appears fairly positive, with the caveat of potential future uncertainties.

Got it. Very helpful. And then just one follow-up for me. I think on last quarter's call, you guys addressed kind of credit availability broadly. And I think you mentioned you saw some initial signs of tightening from the above or trade down in other words. Any update there?

Yes. In the last quarter, we noted that we had only recently started to notice some changes in our applicant flow at the top of the funnel. The best way to monitor this is through FICO scores and our own internal risk scores for applicants in the highest segment of our application funnel. What we observed in late April, which had just begun, continued throughout the quarter. We have seen an increase in our FICO scores across our application funnel, especially in the top segment. However, there has been some reported inflation in FICO scores, meaning that a score of 660 may not perform as it did a few years ago. We are monitoring this closely. As mentioned in our prepared remarks, it is challenging to gauge the extent of any potential benefit from this for us, so we have not incorporated any significant material benefit into our outlook. Nevertheless, we have long believed that it could serve as a potential tailwind for our business.

So it seems like the guidance implies a worsening of margins in the second half of the year, both versus the first half and also for year-over-year basis. You talked about it a little bit in the prepared remarks, but can you just walk through why gross margins would soften in the second half? And then also what's driving that step up in SG&A spending as well?

Yes, Kyle. This is Brian. The situation we're facing is that we're starting with a lower gross lease asset balance in the latter half of the year. This will impact our total revenue negatively. We have some fixed costs in our SG&A structure, and with the lower revenue coming in, this will pressure our margins. Additionally, SG&A is expected to increase due to various technology initiatives and improvements in our back office, as well as our sales and marketing efforts. Looking ahead to the end of the year and into next year, we aim to increase our gross lease asset balances as we close out the year. This is the main reason for the margin pressure expected in Q3 and Q4, which aligns with what we previously communicated in our outlook. We anticipated this increase in SG&A and the revenue challenges from the declining gross lease assets at this stage in the year.

That's great. For my follow-up, what margins are you expecting in 2023? Is that a good framework to use for 2024 and beyond? Historically, you've mentioned that for the Progressive segment, the goal is to achieve EBITDA margins in the 11% to 13% range. Based on the guidance, it seems you should remain within that range this year. Is the expectation to grow revenue while maintaining that margin rate, or do you aim to increase margins from this point?

I'm not going to provide specific details about 2024, but from a long-term margin perspective, our current position and trends are comfortable for us. This has been achieved through active portfolio management and aligning selling, general, and administrative expenses with our top-line performance. The 11% to 13% margin range for Progressive Leasing remains the same, with Progressive Leasing achieving about 13.5% for Q2, which is a strong quarterly result. I don’t anticipate it staying that high consistently, but we had an excellent quarter. I believe that 11% to 13% is a solid guideline for the long term.

I wanted to follow up on the GMV a bit. I was wondering if you could talk a little bit more about how you're thinking about the cadence of GMV in the second half of the year; does seem like in the end market, what we're hearing out of retailers is kind of getting less bad and in some cases, even retailers moving to positive territory more recently. So again, curious a little bit more how you're thinking about GMV growth in the second half. And then if you could also just remind us how much of a headwind the underwriting has been as we think about maybe what the more organic run rate trends have been?

Yes, Brad. We provided a range of negative mid-single digits for Q3 and haven't addressed Q4 from a GMV perspective yet. Looking back at Q2, we noted similar trends from the retail earnings season, where April was tough, May showed improvement, and June continued that trend. I expect we will also benefit from a less challenging situation in Q3. Additionally, we are lapping last year's decision tightening, which has contributed to about two-thirds of our negative GMV pressure. Regarding approval rates, we typically analyze a trailing four-week average since approvals last about 90 days. It's uncommon for someone to finalize their lease on the 89th day, so it takes some time for those approved leases to impact funded GMV. Currently, we are still a few weeks away from reaching parity with last year due to decision changes made late in Q2 last year. While there remains a bit of a headwind, it has certainly lessened as the quarter goes on. I am also encouraged by our retailers' willingness to deepen partnerships and utilize our tools, which we've discussed for several quarters, with urgency to implement these solutions before the holidays this year. Time is critical as we approach the busy season for most retailers. If we can accomplish some of these integrations, we anticipate positive outcomes for the remainder of 2023 and into 2024.

That's great. And then, Steve, you all talked about what you're seeing kind of above you all in the write stack, but I was curious if you could comment a little bit more about what you're seeing from a competitive standpoint? Are you seeing those in the lease-to-own group tightening more? Are you seeing anyone loosening? Do you feel like competitors are playing defense here? Are they getting more aggressive to trying to win business away from you? I'm just curious what you're seeing out there right now.

Yes. I mean competition is strong as it usually is. And as we always talk about the bifurcated business, the book of business that we have with the enterprise accounts and their exclusivities along with the regionals where there may be multiple players there. I would not say that I've seen the evidence that our competitors are tightening from an approved rate standpoint. In fact, on the margin, it might be a little bit the other way. And so the competition remains strong and we're out there fighting day to day.

Congrats on a nice quarter. So can you just provide some more color on the build product? I guess I was getting a little confused on that. What exactly is that? And when would you be rolling that out?

Thank you, Anthony. Build is a credit builder loan that combines features of a credit builder loan with a savings accumulation option, and we are pleased to partner with WebBank to provide this service. We have many customers who frequently reach out to us, expressing a desire to enhance their credit scores. While credit builder loans are not a new concept, they can be effective when implemented correctly. We are excited to add this product to our suite, as it supports our goal of empowering our customers financially. There are many opportunities for us to attract new customers through Build. Due to our approval rates, we turn down a number of applicants each year, but we believe that offering them the Build product can help them progress toward lease approvals and possibly transition to better credit options over time. Build has already launched, although it's not available in every state yet; we anticipate being fully operational nationwide by the end of this year. We have active customers and loans, and we will also be introducing a secured card that will allow customers to access their accumulated savings. We plan to engage in cross-marketing and promotional activities to help our customers utilize Build and enhance our leasing business simultaneously.

Got it. And just a follow-up. So how is that being marketed? Is that being marketed under Progressive or under WebBank?

It's being marketed under Bill. Bill is the product's name. Gitbuild.com, and it is being marketed through to the Progressive database, but also in other forms.

I guess my first question is, Steve, can you guys just provide any type of context or numbers to kind of maybe help us understand the number of customers that are hanging on the leases longer than maybe historical standards? Because I'm just asking in the sense that as we roll into next year, this behavior could be relatively unique. And I'm trying to get a gauge on the size of that or any type of estimate just to help us think about it.

Yes. We have not shared the revenue details regarding the 90-day buyout or the number of customers involved. I can say that this has been the main factor driving the improvement in our gross margin that you've seen so far this year, along with strong overall customer performance in paint. We expect the lower 90-day take rate to diminish over time. As I mentioned earlier, the year-over-year variance compared to pre-pandemic levels is anticipated to narrow as the year progresses. Looking ahead to next year, we'll closely monitor customer behavior. However, we have not disclosed the specific revenue portion coming from Magna. Therefore, the normalized gross margins we experienced prior to the pandemic are likely what we expect over the long term, and we are not counting on this situation being a permanent aspect of our model.

Okay, that makes sense. And then I guess to follow up on that, then the right way to think about like the flow-through of the guidance is not necessarily that you're betting the 90-day behavior continues. It's just more that you feel more comfortable about those customers that didn't buy out staying on lease longer. So you're implying some of that upside that's been taking place actually continues in 3Q and 4Q. Is that correct?

Yes. I think you're right on that. There's two primary components from the previous outlook to the current outlook that would highlight our the 90-day is certainly at the top of the list and the performance we've seen in Q1 and Q2 now, like Steve mentioned, what do those customers do and where do they go from a performance standpoint after they elect not to do the 90-day buyout? I think what we've got incorporated in the model is some level of degradation or an allowance for some performance decline from where it's been right now. And if payments continue the way they have been in the first half, then that's upside to the base case that we've laid out. But we are not counting on the customer kind of at this elevated level of portfolio performance and the low level of 90 days. So 90 days will start to normalize a bit as we move throughout the year; payment performance will show maybe a slight tick down from where we've been in the first half. But overall, still has incorporated in the year with strong EBITDA performance and EBITDA margins along the lines of what we would have expected. So I think that's the commentary I give.

Okay. Lastly, could you provide any updates on the product category performance within GMV? We previously mentioned that some larger ticket home durable categories saw increased earnings during the pandemic. Is there anything noteworthy to highlight regarding product categories within the GMV and their performance over the quarter?

No, Bobby, nothing that we would note. I mean, obviously, we participate in the categories and how they're doing generally, but we can also have results that might deviate from that just because of some new integration or new initiative that we're doing within a door. And so obviously, we're focused on all the categories and some are stronger and some are weaker, but nothing specific to call out. Thank you. I'd like to, again, thank you for joining us this morning and for your continued interest in PROG Holdings. Our teams did a great job and delivered another strong quarter. We feel good about the positioning of our portfolio, and we're making the right investments in people and technology to further our three-pillar grow, enhance, expand strategy. We look forward to updating you on our progress next quarter, and hope you have a great day.