Elevate Credit, Inc.
Q4 2019 Earnings Call Transcript

Published: 11 Feb 2020

[Operator:]

Greetings, and welcome to the Elevate Credit Fourth Quarter 2019 Earnings Call. [Operator Instructions]. Please note, this conference is being recorded.I will now turn the conference over to our host, Daniel Rhea, Chief Communications Officer. Thank you. You may begin.

[Daniel Rhea:]

Good afternoon, and thanks for joining us on Elevate's Fourth Quarter and Full Year 2019 Earnings Conference Call. Earlier today, we issued a press release with our fourth quarter and full year 2019 results. A copy of the release is available on our website at elevate.com/investors. Today's call is being webcast and is accompanied by a slide presentation, which is also available on our website. Please refer now to Slide 2 of that presentation.Our remarks and answers will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These forward-looking statements are subject to risks that could cause actual results to be materially different from those expressed or implied by such forward-looking statements. These risks include, among others, matters that we have described in our press release issued today, our most recent quarterly report on Form 10-Q and other filings we make with the SEC. Please note that all forward-looking statements speak only as of the date of this call, and we disclaim any obligation to update these forward-looking statements.During our call today, we will make reference to non-GAAP financial measures. For a complete reconciliation of historical non-GAAP to GAAP financial measures, please refer to our press release issued today and our slide presentation, both of which have been furnished to the SEC and are available on our website at elevate.com/investors. We do not provide a reconciliation of forward-looking non-GAAP financial measures due to our inability to project special charges and certain expenses.Joining me on the call today are Chief Executive Officer, Jason Harvison; and Chief Financial Officer, Chris Lutes.I will now turn the call over to Jason.

[Jason Harvison:]

Good afternoon, and thank you for joining our fourth quarter and year-end 2020 conference call. I'd like to begin the call with a quick review of 2019, because I think it's a year that says a lot about our approach to the business and how we execute against our strategic goals.As you all know, 2019 was a year of change for Elevate, and we both revamped and implemented new credit models across our full slate of products. Additionally, we took a new approach to originations with a focus on measured growth and expanding profitability. Most importantly, we continued to serve customers well.If you turn to Slide 3, you'll note our platforms have now served more than 2.4 million individuals, and we take a lot of pride in the fact that we have save our customers more than $6.5 billion over less consumer-friendly payday lending products. As we look back at our full year 2019, I know I speak for more than just Chris and myself when I say how proud we are of the company and our results. Most notably, we achieved record net income for the full year.If we turn to Slide 4, let's quickly review the highlights of 2019. We drove 157% year-over-year increase in net income, grew adjusted EBITDA by 20% and drove margin expansion of nearly 400 basis points. We ended 2019 with a full year adjusted EBITDA margin of 18.6%, which compares to our original long-term goal of 20% margins for the business. We'd also remind everyone that when we set the goal back in 2015, our full year EBITDA margins were closer to 4%.As we mentioned over the past few quarters, the rising percentage of repeat customers in our mix is a sign that we are designing products customers want and need. Our customer satisfaction scores continue to rise. And for 2019, our portfolio-wide satisfaction percentage was 92%. We are humbled to see the comments we get back from our consumers about how our products have enabled them to overcome issue in their lives and rebuild our credit while receiving a lower rate.As we've also noted, the best part of our business is how our financials are aligned to these positive customer outcomes. Repeat customers tend to have lower charge-offs and certainly cost less to acquire from a marketing perspective. In our model, credit and customer acquisition costs are 2 biggest operating expenses. And in 2019, Elevate demonstrated the power of our skill across each. First, on credit, we were pleased to see a 200 basis point improvement in our year-end charge-offs compared to originations, which ended the year at record lows near 20%. Second, for acquisition costs, we ended the year at $207 per customer, which is nearly 16% below last year's $245 mark and materially below our longer-term acquisition range of $250 to $300. We'll talk about our go-to-market strategy more in a minute, but it goes without saying that 2019 was outstanding from a marketing efficiency standpoint. On the whole, the operating efficiency I spoke to drove record net income for Elevate and our shareholders. In a market as large as ours, we've seen many competitors attempt to do what we've done, but a much smaller number of companies have been able to drive the ultimate profitability like we have.As we've noted on our last few calls, Elevate's focus on profitability driven by responsible and measured top line growth is the right management philosophy, and we view our 2019 full year results as a strong vindication of that view.Now as we look ahead, the addressable market for Elevate remains very large. While our measured approach to growth will remain in place, we believe Elevate has never been better positioned to go-to-market following the overhaul of our credit models.If you flip to Slide 5 and we talk about 2020, we are very excited about our opportunity to grow beyond our traditional direct mail marketing by further penetrating and scaling our use of the online credit partner channel. To put some context around the opportunity, the volume potential through the partner and digital channel is a larger and eventually more scalable universe than what's available via direct mail campaigns. We now have the credit models and decisioning tools to tap into this volume and, most importantly, have tested the channel to make sure we can do this without sacrificing on credit and our ultimate profitability.To be clear, we continue to see significant growth opportunity in both our new credit partner channel as well as direct mail channels. That said, I'd like to emphasize our commitment to returns and margins. Our focus remains on profitability and growth, of that profitability for our shareholders, and we expect 2020 to be a continuation of that goal.In that vein, I'd also like to reiterate that our philosophy remains to grow originations at a measured pace, especially as we enter new markets or pursue new marketing channels. Credit performance is top of mind at Elevate and despite the vast opportunity in front of us, we plan with prudence as we think about origination growth.As you can see, the health of our customers and their financial well-being is at the core of what we do every day. Our corporate culture is aligned with our customers, and we are fortunate that returns in our business and the profitability we deliver to our shareholders is also aligned to our customers' well-being.With that said, I'd like to quickly highlight Slide 6, which provides the history of our average APR across the portfolio. Contrary to some opinions, we have experienced the vast majority of our portfolio growth, providing lower-cost loans to our ever-expanding universe of customers. In fact, the average APR for our platform in the past 6 years has been cut in half. In many cases, these reductions are a direct result of consumer-friendly features included in our products that help customers rebuild their credit with lower rates tied to consistent payments. Compared to legacy subprime lending model, we believe this is a night and day difference in the lives of our consumers, and we take a lot of pride that consumers seem to agree as judged by our repeat customers in overall satisfaction scores.On the regulatory front, the new legislation that passed in California will result in a reduction in our California installment loan portfolio. We will, however, continue to serve a small universe of customers in California. As you know, we reward customers with lower interest rate products based on their payment performance and approximately 10% of the California portfolio is eligible for products with interest rates to comply with the new law. It is our intent to continue to serve these customers.Turning to the U.K., Sunny remains profitable. However, without the regulatory clarity, we do not intend to grow the portfolio in 2020. We do continue to see the benefit of maintaining our presence in the space as a preferred and responsible lender given the exit of many of our competitors.Moving on to Slide 7, let's review our financial outlook for 2020. We were forecasting full year 2020 revenue in a range of $750 million to $770 million. This growth forecast of 0% to 3% reflects the regulatory pressures we will experience in the California and Sunny portfolios, which Chris will detail shortly. We expect fiscal year adjusted EBITDA to be in the range of $135 million to $145 million. We are expecting continued strong profitability growth with net income growing between 9% and 25% to between $35 million and $40 million, which translates to a diluted EPS range of $0.80 to $0.90. We believe the 2020 forecast reflects Elevate's continued commitment to our strategic priorities, and we look forward to executing on these plans as we move through the year.I would also like to briefly address our recently approved stock repurchase plan. Our Board of Directors approved an increase of $20 million to our repurchase plan, bringing the total amount of shares that can be repurchased to 25 million. We see value in our repurchase at our current stock price and its ability to improve returns.Now, let me turn the call to Chris.

[Christopher Lutes:]

Thanks, Jason, and good afternoon, everybody. As we discussed during the prior quarter conference call, we were expecting relatively flat loan growth in 2019 as we rolled out the new credit models for our U.S. products and waited for more regulatory clarity in the U.K. regarding affordability complaints.Looking at the top half of Slide 8, combined loans receivable principal as of December 31, 2019, were down $7.7 million or 1.2% on a year-over-year basis. However, loan balances were up $12.1 million or 1.9% on a sequential basis for the fourth quarter versus the third quarter of 2019. This reflects the more measured approach to growth we are taking, limiting new customer acquisition during the early rollout of the new credit models in the first half of 2019 and then gradually expanding the marketing each month. While this approach impacts top line revenue growth, it has resulted in improved gross profit and margins.At the product level, RISE loan balances were up almost $41 million or 13% versus a year ago. Additionally, RISE loan balances grew approximately $23 million during the fourth quarter of 2019. On the other hand, Elastic loan balances were down $37 million compared to a year ago primarily due to a tightening in credit quality in this product over the past year. While Elastic new customer acquisition was very strong in 2018 with almost 100,000 new customers acquired during that year, credit quality deteriorated. This past new year, new customer acquisition was slowed with new customer volume dropping in 2019 by over 50% versus 2018 resulting in lower revenue, but significantly improved profitability and margins. Despite a roughly $9 million decrease in top line revenue for fiscal year 2019 versus fiscal year 2018, Elastic gross profit was up $27 million in 2019 versus 2018, an increase of almost 30%, and Elastic was the most profitable product this year.Turning to the U.K. Sunny loan balances are down $15 million or over 30% compared to a year ago due to continued lack of clarity on the regulatory front. While complaint volumes have been stable for most of the fiscal year 2019, we continue to have discussions with our main regulator, the FCA, regarding affordability assessments for both new and existing Sunny customers, which has resulted in decreased loan originations during the year. The product was profitable during fiscal year 2019, but the continuing decrease in Sunny loan balances is straining our ability to continue to generate a profit. We need to reach an agreement with the FCA on an affordability assessment during fiscal year 2020 to enable us to begin growing the Sunny loan portfolio again in order for this to be a viable ongoing product. This is not a situation where rising complaint expenses are impeding our ability to generate a profit, but rather our ability to come to an agreement with our regulator related to both new and existing customer affordability assessments in underwriting. In other words, which new customers can we acquire? And how often can we lend to existing customers?Staying on this slide, Q4 2019 revenue totaled $186.9 million, down 9.8% from the fourth quarter of 2018. Almost all of the decline in the Elastic and Sunny revenue resulted from what I just discussed. For the RISE product, revenue decreased $2.4 million in the fourth quarter of 2019 versus a year ago. This resulted from a decline in the effective APR of the RISE product, which declined from 138% in the fourth quarter of 2018 to 124% in the fourth quarter of 2019. The average APR of a new RISE FinWise customer is approximately 130%, which is lower than the typical state-licensed RISE customer but with a better credit profile. While this results in top line revenue growth due to a lower APR for the RISE FinWise customer, the gross profit is higher because losses are lower on these customers and they also have a lower CAC. While RISE revenue was down on a year-over-year basis in the fourth quarter of 2019, RISE revenue less net charge-offs were actually up $900,000 on a year-over-year basis.As we head into fiscal year 2020, both loan balances and related revenue will be impacted by the new legislation passed in California and the continued regulatory discussions with the FCA in the U.K. I'll address both of those on the next slide. But first, let's look at the bottom half of Slide 8. We are very pleased with the year-over-year growth in our profitability. Adjusted EBITDA for the fourth quarter of 2019 totaled $31.2 million, a slight decrease from the fourth quarter of 2018. However, for fiscal year 2019, adjusted EBITDA totaled $138.7 million, up 20% from $116.1 million in fiscal year 2018.Net income for the fourth quarter of 2019 totaled $8.3 million or $0.19 per fully diluted share, more than doubling the $4.1 million or $0.09 per fully diluted share in the fourth quarter of 2018. Net income for fiscal year 2019 totaled $32.2 million or $0.73 per fully diluted share, almost tripling $12.5 million or $0.28 per fully diluted share in fiscal year 2018. While not depicted on this slide, return on average equity for fiscal year 2019 was 23.6% compared to 11.7% in fiscal year 2018. The debt-to-equity ratio at December 31, 2019, declined to 3.6 from 4.8 a year ago, and free cash flow for fiscal year 2019 totaled $58.5 million compared to $15.5 million in fiscal year 2018.On Slide 9, we depict the expected impact of the ongoing regulatory discussions in the U.K. and the legislative change in California on fiscal year 2020 revenue. We ended fiscal year 2019 with $58 million in California state-licensed RISE installment loans. We will be able to lend to a portion of those customers under the new California legislation on an ongoing basis. However, by the end of fiscal year 2020, we expect the RISE California portfolio to be under $10 million in loan balances, resulting in a year-over-year loss of revenue of approximately $40 million. Further, the expected continued slowdown or even decrease in Sunny U.K. loan balances could result in an additional $25 million to $30 million loss of revenue in fiscal year 2020 versus fiscal year '19. If we adjust fiscal year 2019 revenue for these 2 items, the expected revenue guidance range for fiscal year 2020 would be 10% to 13% revenue growth over adjusted revenue for fiscal year 2019.Turning to Slide 10. The cumulative loss rates as a percentage of loan originations for the 2019 vintage is the lowest ever, with the new generation of risk scores and strategies that were rolled out in 2019 performing much better than the 2018 vintage, which remained relatively flat with the 2017 vintage. That said, we are continuing to ramp our new generation of credit scores and strategies and are hopeful that we can continue to drive loss rates lower in fiscal year 2020 and future years.On this slide, we also show the customer acquisition cost. For the fourth quarter of 2019, the CAC was $196, down from $202 in the fourth quarter of 2018. For fiscal year 2019, the CAC totaled $207, down from $245 in fiscal year 2018. These decreases are the result of better marketing efficiency in the RISE on Elastic products and diminished competition in the U.K.Slide 11 shows the adjusted EBITDA margin, which was 17% for the fourth quarter of 2019, up from 15% for Q4 2018. The adjusted EBITDA margin for fiscal year 2019 was 19%, up from 15% for fiscal year 2018. All this expansion happened within the gross margin, which increased due to lower loan loss provisioning and marketing spend. Additionally, the decrease in the cost of funds for the debt facilities has also resulted in an expanded net income margin for 2019. On roughly the same amount of average debt in both the fourth quarters of 2018 and 2019, interest expense for the fourth quarter of 2019 was almost $6 million lower than the fourth quarter of 2018.I would like to end by discussing in more detail the fiscal year 2020 guidance and capital management that Jason covered earlier. First off, we will not be adopting CECL this year since we are a small business reporting company. There is no impact on the expected fiscal year 2020 financial performance due to CECL. From a quarterly net income perspective, I expect fiscal year 2020 quarterly net income to be more of a hockey stick than in 2019, where it was more U-shaped. This would result from a smaller decline in the loan portfolio during the first quarter of this year due to increased marketing to new customers versus a year ago when we had not yet rolled out the new credit models. While Q1 2020 will probably have a year-over-year decline in revenue, we expect Q2 through Q4 2020 to see quarterly year-over-year revenue growth despite the paydown of the California RISE portfolio and continued slow growth in the U.K. loan balances. There may be some quarterly volatility in CAC and adjusted EBITDA margins due to new customer acquisition and loan growth, and we expect the fiscal year 2020 adjusted EBITDA margin to be relatively flat with fiscal year 2019 due to the added marketing spend and loan loss reserve build resulting from loan growth.We intend to hold operating expenses relatively flat with fiscal year 2019 outside of continuing slight increases in noncash stock-based comp and depreciation expense. Interest expense should decrease on a year-over-year basis due to fiscal year 2020, receiving the full year benefit of the prior reductions in the cost of funds on all products plus an additional built-in 25 basis point reduction that was effective January 1, 2020, for all debt facilities. We also intend to pay off the remaining $18 million in sub debt during the first quarter of 2020. We would incur a small $600,000 penalty associated with this prepayment.Lastly, I would like to briefly discuss the additional $20 million common stock repurchase plan authorized by our Board. We believe this use of capital at the current stock valuation is compelling from a return on capital perspective. We have been buying back shares since August 2019 and so far, in fiscal year 2020, have already fully utilized the $5 million authorized last July by the Board for our fiscal year 2020 10b5-1 plan. We intend to establish a new 10b5-1 plan for this additional $20 million authorization once we are in an open window from a legal and regulatory perspective. The fully diluted EPS guidance for fiscal year 2020 assumes no repurchases of stock at the low end of that range to be ultra-conservative and would assume full utilization of the buyback ratably throughout fiscal year 2020 at the high end of that EPS range. We intend to begin buying again under this new $20 million authorization as soon as we are able to implement the new 10b5-1 plan.With that, let me turn the call back over to Jason.

[Jason Harvison:]

I'd like to conclude by highlighting the enormous non-prime market in the U.S. and U.K. Non-prime consumers deserve responsible loan products designed to fit their needs. We get up each day ready to meet that need and provide a better tomorrow for non-prime customers. Our diversification from a product standpoint positions us well to serve this space into the future. We look forward to continued growth of the company and adding shareholder value in 2020.And with that, I'll turn the call over for your questions.

[Operator:]

[Operator Instructions]. Our first question comes from David Scharf with JMP Securities.

[David Scharf:]

First, curious on the credit front, obviously, the strong performance is consistent with what we're seeing from a lot of subprime lenders. But it sounds like you've had a very big improvement in the credit quality of the customers coming into the partner channel versus a year ago. Are those at parity now with your sort of direct mail, direct acquisition? Or is there still room to improve there?

[Jason Harvison:]

Yes, David, this is Jason. I think we're seeing that come into line with the other channels. What we were able to do in 2019 was

[David Scharf:]

Okay. Got it. And switching gears, I kind of asked this last quarter, maybe just a little bit of an update on sort of, maybe, timing in the U.K. because I know the regulators there tend to have sort of a habit of drag in their feet and getting some more visibility or clarity on, in this case, the affordability test. Do you have any sort of drop-dead date, if you will, for when a decision will be made whether to maintain that product? Because as you noted, at the current level of scale, it sounds like it doesn't make sense to continue with Sunny. I mean, do you have sort of a deadline in mind when you want to get kind of a go or no-go decision from the FCA?

[Jason Harvison:]

Yes. One thing I will say that the team has done a good job of interacting with the FDA and having conversation there to keep progressing forward. There's no set time line with the FDA or internally. But as Chris mentioned in his comments, we've got to make sure the business is at a decent scale, so we cannot just be profitable but to see the foresight to continue to go back in growth mode. So that's something we're going to be having more conversations with the FCA about over the coming months.

[David Scharf:]

Got it. And one last one. I appreciate all the color, the granularity on breaking out the revenue impact from the California legislation. Should we be interpreting this as -- that the -- I mean, the existing bank partner in California no longer wanting to continue to underwrite there? Or is there a different mechanical reason for the falloff?

[Jason Harvison:]

No. What we outlined there was the RISE portfolio, where we were licensed in the state that was impacted by the bill that passed. And that's where with that RISE portfolio, we had about 10% sitting at a 36% APR, so that we were able to continue to serve those under the new legislation that was passed.

[Operator:]

Our next question comes from Brian Hogan with William Blair.

[Brian Hogan:]

I've got a question. First one is actually on the margin outlook. And I appreciate your flat -- your comments on the flat margin. I guess your long-term 20% plus margin, I mean, should we expect it to get there eventually? Or what is the progress in the margin outlook?

[Christopher Lutes:]

Yes. Brian, it's Chris. Yes, I think the guidance for 2020 is predicated back into getting into good growth mode, even including the paydown of the California portfolio that we talked about and even assuming flattish growth in the U.K. So that will probably compress the margins and keep them relatively flat with 2020. But we have lots of upside in the margin when you look out beyond 2020 really across all components. I mean, our loss rates continue to perform better and better each year with each vintage. The customer acquisition cost is almost at historical lows for us, and we don't see any slowdown from that perspective.And then really, what we haven't really tapped into yet the past couple of years, but that I tried to highlight in this call, and we'll see a lot more benefit in 2021, once we start really driving the revenue growth, will be the operating expense leverage. And then the other factor that falls outside of the EBITDA margin but certainly is going to play a big role here in 2020 and beyond is the drop in the cost of funds and our ability to not only just see the overall interest rate drop, but as we continue to throw off a tremendous amount of free cash flow we're going to be able to continue to self-fund a lot of loan growth on a go-forward basis in addition to buying back the shares. And so as a result, I think you'll continue to see our interest expense as a percentage of revenue continue to drop in addition to just the natural cost of funds. And as a result, I think the net interest margin is really going to start to expand even more as we get into 2021.

[Brian Hogan:]

Sure. And then you kind of touched on that in your answer there. But how do we think about long-term growth as kind of -- this kind of shift and retool the business and credit profile, and we're going to start seeing a reacceleration in growth? How do we think about longer-term-type growth rates? What is an appropriate growth number longer term?

[Jason Harvison:]

Yes. I mean, I think Chris highlighted in some of his opening remarks, where if you back out the impact of California and the U.K., the guidance for 2020 would be a 10% to 13% type revenue growth. I think as we look going forward, we won't give -- I haven't got an assist yet, but I think the high single digits kind of low 10% to 12% range is probably an area we'd be looking to target to keep that focus on credit quality and measured growth.

[Brian Hogan:]

All right. And just can you touch on the regulatory environment statewide? What are you focused on in these states, in particular, obviously, California and the national discussion? Just kind of any touch on the regulatory environment, please.

[Jason Harvison:]

Yes. I mean, obviously, the change in California was one that we think impacted non-prime consumers not in a great way, because it limited access to credit for them. Our hope is that other states will watch and see what happens on where those consumers go, what products they end up using. Right now, as we do our outreach and government relations, we're not seeing anything else that's out there, but that's something we stay in tune to.

[Operator:]

[Operator Instructions]. Our next question comes from John Hecht with Jefferies.

[John Hecht:]

Most of my questions have been asked. I guess one is just thinking about your commentary for the RISE product, given the moving parts to California, but then you have some organic growth elsewhere. How will -- the RISE portfolio over the course of the year, will it be static, will it shrink a little bit? Or how do you think about the cadence there?

[Christopher Lutes:]

Yes. John, this is Chris. As I look out, I think, from a conservative standpoint, I think that it's going to remain relatively flattish. I mean, if we're going to lose roughly almost $50 million of California state licensed RISE loan balances as they paydown through the course of the year, I think there's going to be other opportunities with us with the RISE product, not in California, excluding California, that we'll be able to kind of replenish what we lose in California and overall kind of see a flattish. Is there upside on that? Yes, possibly as we explore some other states. And then certainly, as we get into next year, the RISE portfolio on a normalized basis will be able to start growing again.

[John Hecht:]

And then on the Elastic portfolio, looks like the kind of ALL amount is fairly stable. Your charge-offs have -- they've improved year-over-year, but they've also started moving into a more kind of range-bound effect. In that portfolio, is it fairly kind of a run rate it reflects kind of mature portfolio trends now? Or should we expect any migration of those metrics over time?

[Christopher Lutes:]

No. That's the portfolio or the product that this year I expect to grow pretty substantially. That will drive a lot of the top line revenue growth will be the Elastic product. We feel good about the new models that we worked on last year and rolled out. And as a result, I mean, it was a very -- the loss rates are exactly where we want them. The CAC looks really good. I think that's a product given the line of credit nature of it that we can grow that product pretty good here in 2020. So that's one product that I expect to get back into growth mode and drive a lot of our top line and loan growth this year.

[John Hecht:]

Okay. And then any -- just sort of what you -- there was a hearing in D.C. about bank partnerships. Obviously, it's an important time of your business. What's you guys' perspective on that? Is there -- do you think there's any comment at this point in time about what you think is going on?

[Jason Harvison:]

Yes. I mean, I think when we saw in those hearings that it's a complex issue that's out there, we're glad to see that there was good conversation from both sides of the aisle. And the focus there was that both sides of the aisle saw that a rate cap could hurt non-prime borrowers by limiting access to credit. It's still early to figure -- know what's going to happen, what the crystal ball looks like, but I think there was -- we were happy to see some good discussion take place.

[Operator:]

Ladies and gentlemen, there appears to be no additional questions at this time. I'll turn it back to management for closing remarks. Thank you.

[Jason Harvison:]

Just want to thank everyone for the time this afternoon. We're excited about the results from 2019 and happy to get 2020 off to a good start. Thanks, everyone.

[Operator:]

Thank you. This concludes today's call. All parties may disconnect. Have a great evening.