Enova International, Inc. (ENVA) Q3 2017 Earnings Report, Transcript and Summary

Good afternoon and welcome to the Enova International third quarter 2017 earnings conference call. All participants will be in a listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Monica Gould. Please go ahead.

Thank you Brian and good afternoon everyone. Enova released results for the third quarter of 2017 ended September 30, 2017, this afternoon after 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 would like to note that today's discussion will contain forward-looking statements based on the business environment as we currently see it and as such, does include certain risks and uncertainties. Please refer to our press release and our SEC filings for more information on the specific risk factors that could cause our actual results to differ materially from the projections described in today's discussion. Any forward-looking statements that we make 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 U.S. GAAP reporting, we report 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 would like to turn the call over to David.

Thanks Monica and good afternoon everyone. Thanks for joining our call today. As usual, I am going to start by giving a brief overview of the quarter, then I will update you on our strategy and finally, I will share our perspectives looking forward. After remarks, I will turn the call over to Steve Cunningham, our CFO, to discuss our financial results and guidance in more detail. In Q3, we continued to focus on growing our six businesses and we are pleased with the performance and profitability we generated. Third quarter revenue was at the high end of our guidance at $218 million, an 11% increase over the third quarter of last year as we saw healthy demand across our products. Adjusted EBITDA for the quarter was $34.2 million and adjusted net income of $8.6 million or $0.25 per share was also at the high end of our guidance ranges. These strong financial results were driven by continued solid credit combined with efficient marketing, which offset somewhat higher non-marketing operating expenses from variable loan transaction related expenses as well as investments in technology and analytics personnel to support growth. As I just mentioned, we continue to see stable credit metrics across our portfolio. While our net charge-offs are higher than last year, this is almost exclusively attributable to the strong new customer volumes we have seen over the last several quarters. In fact, in Q3 we generated the highest mix of new customers since I have been at Enova. This creates a nice tailwind for us as these new customers increase our revenue generating asset base going forward. Another sign of stable credit was our gross profit margin in Q3 of 51%, which is within our guidance range as our near-term credit performance has been good and we are receiving adequate yields for the credit risk in our portfolio. As was the case in the second quarter, companywide originations in Q3 declined slightly from the prior year. However, our loan and finance receivable balance is up over 15% from last year despite this decline in originations as we have successfully diversified over the past several years, into line of credit and installment products with higher balances and longer durations. Including our small business offerings, installment loans and lines of credit now comprise 88% of our portfolio and 77% of our revenue. The increase in installment loans and lines to credit allows us to grow revenue with lower marketing costs and other expenses. Steve will discuss this in more detail later. Our success and strong results across our short term line of credit and installment and receivable purchase agreement segments continued to be driven by our focus on our six growth businesses. These are our U.S. subprime and U.S. near-prime offerings, our U.K. consumer brands, U.S. small business financing, our installment loan business in Brazil and Enova Decisions, our analytics as a service business. Our large U.S. subprime consumer business generated another strong quarter of profitability. That business continues to grow and become more diversified with 33% of that portfolio consisting of installment products, 45% line of credit products and only 22% single pay products. Across our entire portfolio, single pay products are now less than 12%. In the U.K., loan originations increased 13% from Q3 of last year and the number of new customers was up 12$ year-over-year. We remain the number one subprime lender by market share in the U.K. and see this business generating even higher levels of profitability over time, especially if the pound strengthens. NetCredit loan balances rose to end the quarter at $330 million, which is up 15% from the third quarter of last year. Our U.S. near-prime product has grown to represents 49% of our total U.S. loan portfolio. Consumer demand for near-prime loans remain strong and we believe NetCredit is well-positioned to continue to serve that market with our quick and efficient online model that is taking share from the brick and mortar incumbents. Our small business financing products represented 11% of our total portfolio at the end of Q3 while originations decreased 17% year-over-year, reflecting the more cautious approach we discussed for this business compared to year ago as we navigate the ongoing fallout in this market. Our Brazilian loan portfolio has grown to over $17 million at the end of the third quarter. We have been successful in increasing originations there with Q3 originations up 6% from Q2 and 135% from Q3 of last year. We continue to see a substantial opportunity in Brazil from a combination of a large population, strong demand for credit, a stable regulatory environment and advanced interconnected banking system. Finally Enova Decisions, our real-time analytics as a service business is gaining traction. We have and will continue to evolve the product offerings and we signed several additional contracts during the quarter. While this business is still very small and has much to prove, we are pleased with the initial success so far across a number of different verticals. Now I want to turn to the CFPB rulemaking process. Following the issuance of the CFPB's final rule on small dollar landing a few weeks ago, we are more confident than ever in our ability to remain a large and profitable player in the industry. We believe that we are very well prepared and positioned particularly relative to the storefront lenders who will be significantly impacted by the limitation on loan renewals and will struggle to implement the ability to repay underwriting standards under the rules. Moreover, we expect the impact of the proposed regulations to be much smaller than we estimated last year when the preliminary rule is published as a result of a more focused rule as well as our continued diversification. As you may recall, when the rule was released last year, we estimated that based on our revenue mix at the time, products that composed approximately 60% to 65% of our revenue will be subject to the final rule and that revenue for those impacted products could decline by 30% to 40% from the then current levels for total potential revenue impact at that time of 18% to 24%. We now expect the total revenue impact to be less than 10% as products that comprise only 15% to 20% of our second quarter 2017 revenue will be subject to the short term loan specific portions of the rule and products that represent an additional 50% to 55% of revenue may also be subject to the changes to the payment preauthorization process. Now that all assumes that the rule is implemented without additional changes. Now at a minimum, we have nearly two years to adapt to the new rule and by that time we expect that the actual impact to revenue to be substantially below the levels I just mentioned as we continue to execute on a diversification strategy and our growth initiatives expand. In addition, we continue to believe that Enova will have an opportunity to gain substantial market share as storefront lenders struggle to implement the new rule and tribal lenders are forced to comply with federal regulations for the first time. Today we have less than 10% market share in the U.S. subprime market. So it is certainly conceivable that our market share could increase meaningfully. Now all that being said, there is significant uncertainty as to whether this rule will become effective in its current form. There will likely to be several legal challenges to the rule and the specter of a director leaving the CFPB next summer, if not sooner, adds additional uncertainty. In any event, we believe that our sophisticated analytics with more customer history than any other online lender will allow us to quickly adapt and implement any required changes. And our successful diversification efforts should continue to mitigate the impact from regulation. We also have experience at this. In addition to the significant changes in U.K. regulation over the last few years, we have managed through dozens of regulatory changes at the U.S. state level. So to wrap up, we are pleased with our continued progress and the momentum in our business. The macro environment remains favorable and credit continues to be solid. Our commitment to delivering exceptional products and services to customers who trust and count on us is driving our growth and we continue to diversify our business to decrease regulatory risk and spur growth. I remain confident in our direction and believe that a world-class team, focused growth strategy, strong competitive position and solid balance sheet will drive continued success and enable us to achieve our mission of helping hardworking people to fulfill their financial responsibilities with fast trustworthy credit. Now I would like to turn the call over to Steve Cunningham, our CFO, who will go over the financials in more detail. And then following Steve's remarks, we will be happy to answer any questions that you may have. Steve?

Thank you David and good afternoon everyone. I will start by reviewing our financial and operating performance for the third quarter and then provide our outlook for the fourth quarter and the full year 2017. Our financial performance was solid this quarter and represents the eighth consecutive quarter where we have delivered within our guidance ranges. Revenue, adjusted EBITDA and adjusted EPS all came in at the high end of our expectations. Total revenue was $217.9 million in the third quarter, which increased 11.2% from the year ago quarter. Foreign currency exchange rates did not have a significant impact on total company revenue compared to the third quarter last year. Year-over-year revenue growth was driven by growth in total company combined loans and finance receivable balances which increased 15.6% year-over-year to $771.7 million from $667.3 million in the third quarter of last year. Line of credit products and installment loan products continue to drive the year-over-year increases in total loans and finance receivables balances. Total company originations rose sequentially by 10.9% and decreased 2.3% year-over-year. As David mentioned, the strong growth in total company combined loans and finance receivables balances combined with slightly lower total company originations reflects on the effectiveness of our diversification based on our strategy of focused growth across our six businesses. In particular, we have been generating faster receivables growth in our line of credit and installment loan products across our six growth businesses. These products have longer durations and have higher average loan amounts. As a result, we are able to drive higher receivables and revenue growth with fewer originations resulting in less effort at lower costs. This is a contributing factor to the recent trend of lower marketing expense as a percentage of revenue. While we may see some variation from quarter-to-quarter, we expect these trend to continue for the foreseeable future. Domestically, revenue increased 9.8% on a year-over-year basis and increased 14.9% sequentially to $181.6 million in the third quarter. Domestic revenue accounted for 83.3% of our total revenue in the third quarter of 2017. Revenue growth in our domestic operations was primarily led by a 16.8% increase in domestic line of credit revenue and a 13.4% increase in domestic installment loan and receivables purchase agreement revenue. Continued strong demand for these products drove our domestic combined loan and finance receivable balances up 14.3% year-over-year. International revenue increased 18.6% on a year-over-year basis to $36.3 million and accounted for 16.7% of total company revenue in the third quarter. On a constant currency basis, international revenue increased 18.4% on a year-over-year basis. International revenue growth was primarily driven by a 34.6% increase in international installment loan revenue as we have had good recent success with our installment loan products in the U.K. and are benefiting from the continued growth of our Brazilian business. International loan balances were up 25.1% year-over-year and 13% sequentially. On a constant currency basis, international loan balances were up 21.1% year-over-year. Turning to gross profit margins. Our third quarter gross profit margin for the total company was 50.7%, which compares to a gross profit margin of 51.3% in the third quarter of last year. The modest decline in gross profit margin was in-line with our expectations given the continued growth and the proportion of new customers in originations and the greater mix of near-prime installment loans in the portfolio. Domestic near-prime installment loans grew 15.1% year-over-year and now comprise 43% of total company combined loans and finance receivable balances at the end of the quarter. Across all of our businesses, originations from new customers totaled 30% during the third quarter. This is the highest proportion we have seen in any recent quarter. The higher proportion of new customer originations has been particularly noteworthy in our CNU and NetCredit businesses. We are very pleased with our ability to continue to attract new customers as it sets us up very well for the future. However, as we have stated on prior calls, a higher mix of new customers in originations requires higher loss provisions upfront as new customers default at a higher rate than returning customers with a successful history of payment performance. Given these recent trends, net charge-offs as a percentage of average combined loans and finance receivables increased slightly for the third quarter of 2017 to 11.9% from 11.7% in the third quarter of last year. The modest increase year-over-year was driven primarily by the continued seasoning of new customers originated in recent quarters, particularly in our short term and installment loan portfolios and was in-line with our expectations. We continue to expect consolidated gross profit margin to remain in the range of 50% to 60% and will be influenced by the pace of growth in originations, the mix of new versus returning customers in originations and the mix of loans and financings in the portfolio. Our domestic gross profit margin of 51.3% in the third quarter increased from 48.1% in the third quarter of last year led by improve credit quality in our line of credit products and partially offset by new customer growth in our installment and short term portfolios. Our international gross profit margin was 47.9% in the third quarter compared to 68.9% in the prior year quarter. The decline in international gross profit margin from the prior year quarter was driven by originations growth in our installment products. We expect our international gross profit margin to range from 50% to 60% and will be driven by the pace of growth in both the U.K. and Brazil as well as the mix of new and returning customers. Turning to expenses. Our total operating expenses were $79.3 million in the third quarter compared to $68.7 million in the third quarter of last year. As David mentioned, we have seen continued efficiency in our marketing spend which was offset this quarter by higher operations and technology and general and administrative expenses compared to a year ago. These expenses were mostly associated with our larger receivables portfolio including transaction fees, servicing, underwriting and legal costs. In addition, personnel costs are higher year-over-year primarily from continued investment in development of our technology capabilities. There are also a number of one-time items in these line items which I will explain. Marketing expenses were $27 million in the third quarter and accounted for 12.4% of revenue which compares to $26.7 million or 13.6% of total revenue in the third quarter of last year. Marketing expenses for the third quarter included a one-time reduction of $1.9 million related to the deferral of certain marketing costs that were incurred in prior periods. We expect marketing spend will remain in the mid teens as a percentage of revenue for the fourth quarter. Operations and technology expenses totaled $27.3 million in the third quarter compared to $20.6 million in the third quarter of last year. Operations and technology expenses for the quarter include a $2.3 million increase from ongoing costs that previously were included in general and administrative expenses. The year-over-year increase outside of this expense re-categorization was primarily due to volume related servicing and underwriting expenses as well as an increase in U.K. customer settlements compared to a year ago. We expect operations and technology expenses to grow with volume and range between 11% to 11.5% of revenue in the fourth quarter. General and administrative expenses were $25.2 million in the third quarter compared to $21.3 million in the third quarter of last year. General and administrative expenses, include a $2.3 million decrease from ongoing costs that were now included in operations and technology expenses. And the quarter also included $900,000 of one-time costs from multiple items. The increase in general and administrative expenses outside of these adjustments was primarily due to higher technology-related personnel costs as well as legal expenses. We expect general and administrative expenses to range between 11.5% and 12% of revenue for the fourth quarter. Adjusted EBITDA, a non-GAAP measure, was flat year-over-year at $34.2 million in the third quarter. Our adjusted EBITDA margin was 15.7% compared to 17.4% in the third quarter of last year. Our stock-based compensation expense was $3 million in the third quarter which compares to $2.3 million in the third quarter of last year. Our effective tax rate for the third quarter was 38.5% compared to 35.4% in the third quarter of last year. The increase in the effective tax rate was primarily due to the impact of higher nondeductible items relative to the year ago quarter. Our effective tax rate for the nine months ending September of this year is 34% compared to 40% for the prior year nine month period. We believe our full-year tax rate will remain in the mid-30% range. Net loss was $3.4 million in the third quarter or negative $0.10 per diluted share which compares to net income of $7.8 million or $0.23 per diluted share in the third quarter of last year. Our GAAP results were impacted by a loss on the early extinguishment of debt during the quarter of $14.9 million as a result of retiring $155 million of our 9.75% notes during the quarter with a portion of the proceeds from our 8.5% unsecured senior note issuance. Adjusted earnings, a non-GAAP measure, totaled $8.6 million or $0.25 per diluted share compared to $9.3 million or $0.28 per diluted share in the prior year quarter. We continued to strengthen our balance sheet during the quarter as we accessed the unsecured senior note market during August to raise $250 million of seven-year notes at 8.5%, which was used to redeem a portion of our existing 9.75% notes in support of liquidity as we move into our seasonal peaks for growth. This follows the placement of our $40 million bank-led secured line of credit last quarter. In addition, today we announced the renewal of our $275 million NetCredit securitization facility. The renewal extends the maturity of the facility to April 2019, lowers our cost of financing and includes flexibility to issue into the term securitization markets. In total, we have raised $565 million at competitive cost during to 2017 across these three markets. During the third quarter, cash flows from operations totaled $125.2 million and we ended the quarter with unrestricted cash and cash equivalents of $110.1 million and total debt of $765.4 million. Our debt balance at the end of the quarter includes $186.5 million outstanding under the $295 million of combined installment loan securitization facilities. Now I would like to turn to our outlook for the fourth quarter and full year 2017. We remain focused on maintaining solid profitability as we further expand our six growth businesses. Our outlook reflects continued strong growth in each of our businesses, a continued higher mix of new customers in originations and no impact to our U.S. business from CFPB rules during 2017. Any significant volatility in the British Pound from current levels could also impact our results. As noted in our earnings release, in the fourth quarter 2017 we expect total revenue to be between $220 million and $240 million, diluted earnings per share to be between negative $0.01 and $0.18 per share, adjusted EBITDA to be between $32 million and $42 million and adjusted earnings per share to be between $0.14 and $0.33 per share. For the full year 2017, we expect total revenue to be between $820 million and $840 million, diluted earnings per share to be between $0.65 and $0.84 per share, adjusted EBITDA to be between $151 million and $161 million and adjusted earnings per share to be between $1.24 and $1.43 per share. And with that, I will hand the call back over to David.

Thanks Steve. And now we will open up the call for any questions you may have.

[Operator Instructions]. First question comes from David Scharf with JMP Securities. Please go ahead.

Hi. Good afternoon. Thanks for taking my questions. David, I am wondering, just to help put things into context, the 30% of origination volume, that was a record coming from new customers. Maybe over the last two years, eight quarters or so, what is the lowest that figure has ever been?

I don't have that eight quarter number, but I can tell you three, four years ago, it was as low as the kind of the low to mid teens. So that number has come way up which is really a terrific sign in the strength of our marketing effort really over the last three, four years. This has been an ongoing improvement from our teams and to be able to increase that number from the low to mid teens four, five years ago when I started here to where we are today is a great sign for our future.

Got it. And as we think about that very wide range of gross margin guidance, the 505 to 60%, obviously so much of that is driven by the mix of new versus repeat users. Do you think this 30% is close to a peak? Or is there a number you even have in mind that you feel not so comfortable going above?

We will take as many new customers as we can get which is why we gave somewhat wide ranges across all of our guidance, because mix is the big driver for that. There is also other factors like the calendar affects our gross margin more significantly than you might imagine, kind of what day of the week the quarter ends on could have a several point swing in our gross margin for that quarter. It will swing back the following quarter. But for a quarter it can have a fairly wide swing. So short term mix, calendar, those kinds of things can move gross margin pretty significantly, which then obviously drives gross profit and can move EBITDA around a lot, which is why our guidance ranges are wide. But that longer-term trend has been very positive and keeping those, we have been able to deliver results within those guidance ranges and when you look deeper into the business with metrics like new customer growth and with some of the other credit metrics, we continuously very positive trends.

Got it. And given the variability in product mix shift quarter-to-quarter, I am just wondering, on an annual basis, we realize originations can shift around a lot and it looks like with longer duration larger loans you are growing your balances nicely without having to originate as much. Is the mid teens year-over-year growth in balances for line of credit installment a pretty good way for us to think about the balance sheet growth near-term?

We take that kind of growth rate as sustainable. And hopefully we can do more. But that's certainly not something we view as an anomaly.

Got it. And then lastly and I will jump back in line here. On the renewal of the NetCredit securitization, is there anything on the terms that change materially? I didn't know if there was a reference to the cost of funding there, Steve?

There was, David. There is one. You may remember we had two classes previously. There is one class of issuance now and it's at LIBOR plus 750. You may recall, there was the minimum 9.5% cost in the prior renewal.

Right.

And we will issue once a quarter. So the variable note is a little bit larger than the monthly issuance variable note that we had in the previous renewal.

Got it. Great. Thanks so much guys.

Next question comes from John Rowan with Janney. Please go ahead.

Good afternoon guys.

Hi John.

I am just trying to square up the fourth quarter guidance. It looks like the difference between GAAP and operating is about $0.15. That obviously is not going to all stock-based comp. I am just trying to figure out if there are any type of other one-time items that are coming in the fourth quarter that make that GAAP so large?

You are talking about the GAAP EPS, John?

Yes. There is $0.15 differential between your GAAP earnings per share and your operating earnings per share in the fourth quarter which is a lot better than it typically is.

Yes. So you will see in the 8-K on the securitization renewal that we refinanced all of the existing notes into the new facility. And really the reason for that is it will save us money over the long haul and allowed us to utilize the newer advance rates to draw more liquidity. Similarly to the redemption on the senior notes during the quarter, there will be an upfront charge for that. But overall this is an NPV positive trade. So that's really what's happening with the range from GAAP EPS.

Okay. That makes sense. I just wanted to make sure that wasn't a new run rate with the differential there because obviously that's not all stock-based comp. So you happen to know what the dollar charges are you going to recognize in the fourth quarter for that change?

It will likely be between $5 million and $6 million, non-cash.

Non-cash. Okay. And then when you guys mentioned it in the prepared remarks, David, I think you talked about with the preauthorization to deduct out of accounts under the CFPB rules and how that would potentially impact some of your installment products? Can you give us an idea of how your current policies for authorizing debits out of consumer accounts would juxtapose versus what the CFPB's final rules mandate?

Yes. They are not terribly different because supplement ourselves. We self limit our current debiting process on that loan to a couple of failed attempts in most cases. So the big change isn't the number of debits, it's getting reauthorized when we talk to the customer to set up a payment plan and those kind of things. We don't think that's going to be a major change to our overall processes. We use a lot of good analytics to make sure we have the most efficient and effective debiting as possible within the rules. We use that already to stay within the natural return limits. And so adapting those same analytics capabilities to the new CFPB rules, we don't think is going to have a major impact across our line of credit installment loan products.

Okay. And just last question. Steve, I think you said G&A expense for the fourth quarter between 11.5% to 12% of revenue. Did I hear that right?

That is right.

Okay. Thank you.

[Operator Instructions]. Next question comes from Michael Del Grosso with Jefferies. Please go ahead.

Hi. Thanks for taking my questions. First one is on the allowance. Seasonally last year we saw a relatively flat reserve quarter-over-quarter from the third to the fourth quarter. Given the new customer mix you mentioned you experienced this quarter, is it fair to expect some more seasonality in that this year?

Yes. I think you would expect to see particularly depending on the mix, there will be growth and new customer mix will obviously drive that. But there definitely is a seasonal aspect to the allowance.

Okay. So when you say growth, we should expect that to tick up a bit? Or are you seeing more flat?

The amount of allowance coverage obviously depends on the mix in the portfolio and the mix of new versus returning. So fourth quarter is obviously our strongest growth period. And as we have mentioned, we are seeing a lot of that growth coming from the non-short term pieces of the portfolio. So there maybe a little bit of comparability issues from prior periods just because of that. But I think you should expect those are going to be the key drivers in terms of where the allowance would sit at the end of the quarter.

Okay. Thank you. That's helpful. And then David, I think last quarter you mentioned you were seeing some state level legislative activity in Maryland? Any update there or any other states we should put on the radar in terms of new activity?

Yes. I mean Maryland was a few quarters ago. We talked about how under the new Maryland rules that went to effect two quarters ago now, we are not allowed to originate new lines of credit in Maryland. We do still have installment lending in Maryland. But we can continue to lend to our existing line of Credit customers in Maryland. So there hasn't been a significant impact there. Beyond Maryland, it's been a little quite because some of them are not in session. They are just kind of getting back into session now. We actually are somewhat optimistic that the final CFPB rule being published will decrease state activity as they will see finally that there is a federal rule out there addressing the space and that will reduce the impetus to try to do something at the state level. We have a couple of indications of that already from a couple of states and we will continue obviously to keep an eye on it as we get deeper into the session here into the late fall and early winter.

Great. Thank you.

This concludes our question-and-answer session. I would like turn the conference back over to David Fisher for any closing remarks.

Thanks everybody for joining us again today. We look forward to updating you on our progress next quarter. Have a good evening.