Standing by, and welcome to the PROG Holdings Second Quarter 2023 Earnings Conference Call. At this time, all participants are in listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] As a reminder, today's program is being recorded. And now I'd like to introduce your host for today's program, Mr. John Baugh, Vice President, Investor Relations. Please go ahead, sir.

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, investor.progholdings.com. 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. With that, I would like to turn the call over to Steve Michaels, PROG Holdings' President and Chief Executive Officer. Steve?

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 2/3 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…

Thanks, Steve. Let me start by summarizing our Q2 highlights. For the second quarter in a row, we exceeded earnings expectations as we effectively managed our P&L in a highly uncertain environment. I want to thank the teams for their perseverance in managing portfolio health and SG&A expenditures in a retail challenged environment and for the pursuit of sustainable long-term growth opportunities. During the quarter, our customer payment behavior remains strong as elevated portfolio yields contributed to increased gross margins in the period. Similar to Q1, we saw fewer customers choosing to utilize 90-day purchase options, yet our write-offs remained within our targeted annual range. As always, we are actively managing portfolio performance as consumer behavior and lease outcomes change. Q2 consolidated revenue declined 8.7% year-over-year due to a lower portfolio balance entering the period. However, revenue exceeded expectations, driven by strong portfolio performance. Consolidated adjusted EBITDA increased by 43.7% to $75 million from $52.2 million in Q2 last year. Our better-than-expected consolidated adjusted EBITDA results were primarily driven by our Progressive Leasing segments, lower SG&A, lower write-offs and stronger gross margins and the favorable SG&A was driven by our focus on operational efficiencies. Non-GAAP diluted EPS increased to $0.92 per share, growing 76.9% from $0.52 per share in Q2 of 2022. We continue to demonstrate the resiliency of our business model and our capacity to adapt to revenue headwinds while preserving margins and cash flow, and I'm extremely proud of our team's efforts to deliver these results. For our Progressive Leasing segment, GMV decreased 14.7% year-over-year, which was slightly better than our internal expectations. We have improved the year-over-year GMV comparison from a 17% decline in Q1 to a 14.7% decline in Q2 and believe we are trending to a mid-single-digit decline for Q3. As Steve mentioned, we believe…

[Operator Instructions] And our first question comes from the line of Kyle Joseph from Jefferies.

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?

Yes. Thanks, Kyle. I guess I'll start. When we spoke last quarter, we talked a lot about fewer consumers choosing to utilize a 90-day buyout option and its impacts on the overall margin -- the gross margin of the business. But what we are trying to assess at that point was how will those pools continue to mature? And would those customers that otherwise during a regular tax season that have -- would have utilized their 9 buyout option, how would they perform. So far today, through Q2, the verdicts that they're performing fairly well. They're making their payments. There are still active leases. And so that's a good sign for the health of our consumer. You mentioned in kind of one of your data points there, strong employment, and that is always a big factor in our business, and we're not seeing any signs of weakness in the employment side of the business or economy, I should say -- as it relates to cost pressures and inflation rolling over, I think that's probably also fairly good news. You can see it in our portfolio performance and what we talked about in the prepared remarks around strong portfolio and strong customer payment behavior. The only -- what I would say, wild card that's out there is a very fluid and developing situation related to this student loan repayment that is facing us in the fall. And there's a lot of puts and takes on that to who will be impacted and what may happen between now and then. So I would say, generally, it's pretty good shape for the consumer with a little bit of a wildcard in the future that may or may not materialize.

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. And any update there?

Yes. What we said last quarter was that we had only very recently begun to see some change in our applicant in the top of the funnel, if you will. And the best way we have to monitor that is basically the FICO scores or -- and even our own internal risk scores of our applicants in the top quintile of our app funnel. And what we saw in late April that had just recently begun, we did continue to see throughout the quarter. So we have seen a drift up in our FICO scores throughout our app funnel, but certainly at the -- in the top quintile. There -- as has been widely reported, there has been some FICO inflation. So a 660 might not perform like a 660 did a couple of years ago. So we're paying attention to that as well. As we mentioned in the prepared remarks, it's difficult for us to, at this point in the year, determine how large, if any, the benefit from that will be for us. But -- and so it's not baked into our outlook, at least the material benefit is not big in our outlook. But we do believe and have believed for a long time that it is a potential tailwind for our business.

Great. That congrats on a good quarter.

Thanks, Kyle.

Thank you. One moment for our next question. And our next question comes from the line of Jason Haas from Bank of America.

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 Loon a 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. Sorry, Jason. This is Brian. The dynamic that's playing out is effectively -- we're starting with a lower GLA balance our gross lease asset balance entering the back half. And so that's going to put pressure on total dollars of revenue, first and foremost. So you've got a fix -- you got some fixed costs within the SG&A structure, you've got a lower revenue stream coming in the back half. So that's going to put some pressure on margins. The other dynamic that is happening is SG&A expected to step up. And that has to do with some technology initiatives, some back-end office initiatives that we are pursuing and also on the sales and marketing front. I think as we look forward to the end of the year and into next, we want to grow the gross lease asset balances or put on a trajectory towards a higher balance as we exit the year. So we can be at a good footing entering into next year. So -- that's the primary reason for the margin pressures in Q3 and Q4. And it's not unexpected from what we communicated in our previous outlook. We'd anticipated this SG&A ramp and some of the revenue pressures from a declining GLA at this point in the year.

That's great. And then for my follow-up, are the margins that you're expecting in 2023? Is that a good framework to use for like 2024 and beyond. I think historically, you've talked about for the Progressive segment. The goal is to be in that 11% to 13% range for EBITDA margins. I think you should be well within that range this year based on the guidance? And then is the expectation just to be able to grow revenue from there and maintain that margin rate? Or is there any -- do you have any goals to grow margins from here?

Yes. I'm not going to get specific on 2024, but I do think from a long-term margin expectation, where we're at this year and where we've been trending, I think, is within a comfortable range for us. And it's not happened on its own. It's been actively managed through portfolio management and watching SG&A and aligning SG&A with our top line performance. And so I think that 11% to 13% that you highlighted for Progressive Leasing remains unchanged. I think it's -- here in the quarter, progressive leasing was about 13.5% for Q2, and that's obviously a very strong quarterly result. I don't expect it to remain that high on a quarter-to-quarter basis. But we had a great quarter. And I think that 11%, 13% is a good guideline for long term.

Congratulations on the strong results.

[Operator Instructions] And our next question comes from the line of Brad Thomas from KeyBanc Capital Markets.

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 did give the range, I would say, of kind of negative mid-single digits for Q3. We did not speak to Q4 as of yet from a GMV standpoint, and that -- I guess as you rolling it back a little bit, as you think about Q2, we heard the same things from the retail earnings season that April was bad in May was less bad and June was less bad. So if you carry those things into the third quarter, I would expect we would participate in that less bad scenario as well. On top of that, we've got the lapping of the decisioning tightening from last year. And we've said a number of times that we believe that about 2/3 of our negative GMV pressures were from the year-over-year decisioning changes or approval rates, if you will. As it relates to approval rates, we generally look at a trailing 4-week average because approvals are good for about 90 days. It doesn't -- it's rare that somebody comes in on the 89th day and funds the lease, but it does take a bit for those approved leases to flow through the funded GMV. And so we look at a trailing 4-week average. And as we sit here today, we're still not -- we're still several weeks away from getting back to parity with last year as those decision changes happened late in Q2 of last year. So still a little bit of a headwind, but certainly less of a headwind as the quarter progresses. And so that's the decisioning and the retail environment. On top of that, I would say I'm encouraged by the receptivity and the partnerships of our retailers looking for ways to deepen our integrations and deploy tools that we have like we've talked about for several quarters, even the sense of urgency to get some of that stuff done before holiday of this year. Obviously, we're fast approaching cores for most retailers. And so time is of the essence. But to the extent we can get some of those done, we look forward to the benefit that can have in the balance of 2023, but also as we roll into '24.

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.

Thank you.

[Operator Instructions] Our next question comes from the line of Anthony Chukumba from Loop Capital Markets.

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?

Yes. Thanks, Anthony. Yes. Build is a -- it's a credit builder loan. So it's a combination of a credit builder loan and savings accumulation vehicle, and we were proud to be partnering with WebBank to offer that. And what we saw there is our -- we serve a lot of our customers quite frequently, and many of them have said that they're looking for ways to improve their credit score or profile, however you want to characterize that. And build is a credit builder loan is not a new product. It's a tried and true way to do that or it can do that if it's done properly. And so we're excited to add it to the PROG ecosystem suite of products, and it helps to further our mission of improving the lives of our customers through financial empowerment. There's lots of opportunities for us to acquire new customers into the ecosystem using build. We -- as you can imagine, with our approval rates, we declined a number of customers every year. And we believe there's -- to the extent that we could offer them to build product and have them grow back into a lease approval and then effectively maybe over time or hopefully, over time, grow into a [indiscernible] or a more near-prime product. And so there's -- we've got a lot of plans for -- well, build is launched, just to be clear, it's not in all states yet, but we expect to be in all states by the end of this year. We have active customers. We have active loans out there. We're going to be launching a secured card that would allow the customers to be able to access the accumulated savings. And we will be doing across marketing, promotional activity between the products to help our customers access build, but also have built helped to grow the leasing business.

Got it. And just a follow-up. So how is that being market -- is that being market 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.

Thank you.

[Operator Instructions] And our next question comes from the line of Bobby Griffin from Raymond James.

I guess my first question is, Steve on, 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. I mean, Bob, we haven't disclosed the revenue component of the 90-day buyout or the number of customers. I guess what I would say is it's the primary driver of the gross margin improvement that you have seen year-to-date. That along -- I mean there's that component and then you've got the strong customer paint performance overall that are influencing gross margins. And so I think our expectations around this lower 90-day take rate is that it will subside over the course of time. And as I mentioned in my prepared remarks, the variance year-over-year versus pre-pandemic is expected to kind of narrow as we move throughout the year. And so as we edge into next year, obviously, we'll take a look at what the customer behavior is. But we have not made public that revenue tranche that is coming from Magna. So I think the way to think about it is normalized gross margins that we experienced pre-pandemic. -- are really probably what we would expect longer term and not necessarily counting on this being a permanent dynamic in the 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 guide 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. There -- I think you're right on that. There's 2 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. And then lastly for me, just any -- we talked last quarter just about some of the product category performance within GMV. Any interesting changes in that? I know some of these larger ticket home durable categories like we overearned a little bit more during the pandemic. So, just anything interesting to call out from a product category standpoint within the GMV and how it played out during the quarter?

No, Bobby, nothing that we would note. I mean, obviously, we are -- 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.

Okay. I appreciate the details best luck here in the third quarter.

Thanks, Bob.

Thank you.

This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Steve Michaels for any further remarks.

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 3-pillar grow, enhance, expand strategy. We look forward to updating you on our progress next quarter, and hope you have a great day.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect.