OPEN LENDING CORP Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)
The following discussion and analysis provides information that management believes is relevant to an assessment and understanding ofOpen Lending Corporation's condensed consolidated results of operations and financial condition. The discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto on Form 10-K for the year endedDecember 31, 2021 . This discussion contains forward-looking statements and involves numerous risks and uncertainties, including, but not limited to, those described under the heading "Risk Factors" set forth elsewhere in this Quarterly Report on Form 10-Q and our Annual Report. Actual results may differ materially from those contained in any forward-looking statements. Unless the context otherwise requires, references in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" is intended to mean the business and operations ofOpen Lending Corporation , and its condensed consolidated subsidiaries. 15
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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that involve substantial risks and uncertainties. Forward-looking statements generally relate to future events or our future financial or operating performance. In some cases, you can identify forward-looking statements because they contain words such as "may," "will," "appears," "shall," "should," "expects," "plans," "anticipates," "could," "intends," "target," "projects," "contemplates," "believes," "estimates," "predicts," "potential," or "continue," or the negative of these words or other similar terms or expressions that concern our expectations, strategy, plans, or intentions. Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about: •our financial performance;
•changes in our strategy, future operations, financial condition, estimated revenues and losses, projected costs, prospects and plans;
•plans and opportunities for expansion;
•the impact of the relative strength of the overall economy, including its effect on unemployment, consumer spending and consumer demand for automotive products;
•the growth in loan volume of our top ten automotive lenders relative to that of other automotive lenders, and the associated concentration of risk;
•costs of services in absolute dollars and as a percentage of revenue;
•general and administrative expenses in absolute dollars and as a percentage of revenues;
•sales and marketing expenses in absolute dollars and as a percentage of revenue;
•research and development expenses in absolute dollars and as a percentage of sales;
•the impact of projected operating cash flow and free cash on our business activities in the future;
•the turnover in automotive lenders, as well as varying activation rates and
volatility in usage of our Lenders Protection Platform ("LPP") by automotive
lenders;
•the outcome of any known and unknown litigation and regulatory proceedings,
including such legal proceedings that may be instituted in connection with the
Business Combination and transactions contemplated thereby;
•the possibility of maintaining the listing of our common shares on Nasdaq;
•our ability to recognize the anticipated benefits of the Business Combination, which may be affected by, among other things, competition and our ability to grow and manage growth profitably;
•expenses associated with our growth due to demands on our operational, marketing, compliance and accounting infrastructure;
•regulatory agreements between us and state agencies regarding matters such as the conduct and supervision of automobile lenders and the pricing of loans;
•changes in applicable laws or regulations;
•applicable taxes, inflation, supply chain disruptions, including global hostilities and responses thereto, interest rates and the regulatory environment; and
•the effects of the ongoing COVID-19 pandemic on our business.
All forward-looking statements are based on information and estimates available to us at the time of this Quarterly Report on Form 10-Q and are not guarantees of future financial performance. We undertake no obligation to update any forward-looking statements made in this Quarterly Report on Form 10-Q to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect new information or the occurrence of unanticipated events, except as required by law. The outcome of the events described in these forward-looking statements is subject to known and unknown risks, uncertainties, and other factors described in the section titled "Risk Factors" and elsewhere in this Quarterly Report on Form 10-Q and our Annual Report. We caution you that the foregoing list may not contain all of the forward-looking statements made in this Quarterly Report on Form 10-Q. You should not rely upon forward-looking statements as predictions of future events. 16
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Company overview
We are a leading provider of lending enablement and risk analytics to credit unions, regional banks and Original Equipment Manufacturers. Our clients, collectively referred to herein as automotive lenders, make automotive consumer loans to underserved near-prime and non-prime borrowers by harnessing our risk-based pricing models, powered by our proprietary data and real-time underwriting of automotive loan default insurance coverage from insurers. Since our inception in 2000, we have facilitated over$14.7 billion in automotive loans, accumulating over 20 years of proprietary data and developing over two million unique risk profiles. We currently cater to 411 active automotive lenders. We specialize in risk-based pricing and modeling and provide automated decision-technology for automotive lenders throughout theU.S. We believe that we address the financing needs of near-prime and non-prime borrowers, or borrowers with a credit bureau score between 560 and 699, who are underserved in the automotive finance industry. Traditional lenders focus on prime borrowers, where an efficient market has developed with interest rate competition that benefits borrowers. Independent finance companies focus on sub-prime borrowers. Borrowers that utilize the near-prime and non-prime automotive lending market have fewer lenders focused on loans with longer terms or higher advance rates. As a result, many near-prime and non-prime borrowers turn to sub-prime lenders, resulting in higher interest rate loan offerings than such borrower's credit profile often merits or warrants. We seek to make this market more competitive, resulting in more attractive loan terms. Our flagship product, LPP, enables automotive lenders to make loans that are largely insured against losses from defaults. We have been developing and advancing the proprietary underwriting models used by LPP for over 20 years. We believe LPP provides significant benefits to our growing ecosystem of automotive lenders, automobile dealers, borrowers and insurers. A key element of LPP is the ability to facilitate risk-based interest rates that are appropriate for each loan and lender and electronically submitted to our automotive lenders within approximately five seconds after we receive a loan application. Our interest rate pricing is customized to each automotive lender, reflecting the cost of capital, loan servicing costs, loan acquisition costs, expected recovery rates and target return on assets of each automotive lender. Using our risk models, we project monthly loan performance results, including expected losses and prepayments for automotive lenders that use LPP. The product of this process is a risk-based interest rate, inclusive of elements to recover all projected costs, program fees and insurance premiums, given the risk of the loan, to return a targeted return on asset goal. We believe that our market opportunity is significant. The near-prime and non-prime automotive loan market is estimated at$250 billion annually. We are currently serving less than 2% of this market, providing a significant growth opportunity. Executive Overview We facilitate certified loans and have achieved financial success by increasing our penetration of the near-prime and non-prime automotive loan market while diversifying our customer base and refining our data analysis capabilities.
We facilitated 43,944 certified loans in the three months ended
The total turnover was
The operating result was
The net income was
Adjusted EBITDA was
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Strong points
The table below summarizes the insured loans facilitated and the number of contracts signed with automotive lenders for the three months endedMarch 31, 2022 and 2021. Three Months Ended March 31, 2022 2021 Value of insured loans facilitated (in thousands)$ 1,182,567 $ 780,341 Average loan size per certified loan $ 26,911$ 23,421 Number of contracts signed with automotive lenders 18 14 Key Performance Measures We review several key performance measures, discussed below, to evaluate business and results, measure performance, identify trends, formulate plans and make strategic decisions. We believe that the presentation of such metrics is useful to our investors and counterparties because such metrics are used to measure and model the performance of companies such as ours, with recurring revenue streams.
Certified Auto Loans
We refer to "certified loans" as the number of loans facilitated through LPP during a given period. Additionally, we refer to loans with a one-time upfront program fee payment as "single-pay" loans. For certain loans, the program fee is paid to us over 12 monthly installments and we refer to these loans as "monthly-pay" loans.
Average Program Fee
We define “average program fee” as the total program fee revenue recognized for a period divided by the number of loans certified during that period.
Overall underwriting profit of insurers
We define "insurers' aggregate underwriting profit" as the total underwriting profit expected to be received by insurers over the expected life of the insured loans. Insurers' Earned Premium
We define “insurers earned premium” as the total insurance premium earned by insurers during a given period. Earned premiums were
Recent Developments Product Update As part of our ongoing efforts to provide our customers enhanced technology and underwriting decisioning, we routinely evaluate program and system updates to LPP. As a result of these efforts, we have completed the following product updates to LPP in the first quarter of 2022:
• Term limits of 84 months for all business channels for approved vehicles; and
• increase in the maximum initial loan amounts for all chains.
Customer rollout of these updates has been initiated and will continue through the second quarter of 2022. These recent updates will provide our lenders with expanded lending opportunities beyond the LPP product parameters previously in place.
Fourth insurance partner
OnMay 2, 2022 , we signed a program management agreement with a fourth insurance carrier partner,Arch Specialty Insurance Company , a part of Arch Capital Group Ltd., who will act as an additional provider of credit default insurance policies for LPP, from which we can earn profit share revenue and claims administration fees. 18
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Main factors affecting operating results
Our results of operations and future cash flows depend on a number of opportunities, challenges and other factors, including growth in the number of financial institutions and volume of transactions, competition, assumptions of profit sharing, industry trends and general economic conditions.
The main factors affecting our operating results are as follows:
Growth in the number of financial institutions
The growth trend in active automotive lenders using LPP is a critical factor directly affecting revenue and financial results. It influences the number of loans funded on LPP and, therefore, the fees that we earn and the cost of the services that we provide. Growth in our active automotive lender relationships will depend on our ability to retain existing automotive lenders, add new automotive lenders and expand to new goods and services specific to our industry.
Competition
We face competition to acquire and maintain automotive lenders as customers, as well as competition to facilitate the funding of near-prime and non-prime auto loans. For LPP, which combines lending enablement, risk analytics, near-prime and non-prime auto loan performance data, real-time loan decisioning, risk-based pricing and auto loan default insurance, we do not believe there are any direct competitors. The emergence of direct competitors, providing risk, analytics and loss mitigation, which are core elements of our business, could materially impact our ability to acquire and maintain automotive lender customers. The near-prime and non-prime lending market is highly fragmented and competitive. We face competition from a diverse landscape of consumer lenders, including traditional banks and credit unions, as well as alternative technology-enabled lenders. The emergence of other insurers, in competition with our insurers, could materially impact our business.
Benefit sharing assumptions
We rely on assumptions to calculate the value of profit share revenue, which is our share of insurance partners' underwriting profit. For example, positive change in estimates associated with historical vintages generate an increase in our contract asset, additional revenues and future expected cash flows, while negative change in estimates generate a decrease in our contract asset, a reduction in revenues and future expected cash flows. To the extent these assumptions change, our profit share revenue will be adjusted. Please refer to " Critical Accounting Policies and Estimates " for more information on these assumptions.
Industry trends and general economic conditions
Our results of operations have in the past been fairly resilient to economic downturns but in the future may be impacted by the relative strength of the overall economy and its effect on unemployment, consumer spending and consumer demand for automotive products. As general economic conditions improve or deteriorate, the amount of disposable income consumers have tends to fluctuate, which in turn impacts consumer spending levels and the willingness of consumers to take out loans to finance purchases. Specific economic factors such as interest rate levels, changes in monetary and related policies, market volatility, supply chain disruptions, consumer confidence, the impact of the pandemic and, particularly, the unemployment rate also influence consumer spending and borrowing patterns.
Concentration
Our two largest insurance carrier partners accounted for 38% and 14% of our total revenue during the three months endedMarch 31, 2022 and accounted for 44% and 22% of our total revenue during the three months endedMarch 31, 2021 . Termination or disruption of these relationships could materially and adversely impact our revenue.
Components of operating results
Total revenue
Our revenue is generated through three streams: (i) profit share, (ii) program
fees paid to us by lenders and (iii) claims administration service fees paid to
us by insurance partners.
Profit share. Profit share represents our participation in the underwriting
profit of third-party insurance partners who provide lenders with credit default
insurance on loans the lenders make using LPP. We receive a percentage of the
aggregate monthly insurance underwriting profit. Monthly insurance underwriting
profit is calculated as the monthly earned premium less
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expenses and losses (including provisions for incurred but unreported losses), with accumulated and carried forward losses for future profit share calculations.
Program fees. Program fees are paid by automotive lenders for the use of LPP, which provides loan analytics solutions and automated issuance of credit default insurance with third-party insurance providers. These fees are based on a percentage of each certified loan's original principal balance and are recognized as revenue upfront upon receipt of the loan by the consumer. The fee percentage rate varies by type of loan. For loans with a one-time upfront payment, there is a sliding scale of rates representing volume discounts to the lender with fees generally capped at$600 per loan. This cap may vary for certain large volume lenders. For monthly pay loans, the fee paid by the lender is a flat 3% of the total amount of the loan and is not capped. Claims administration service fees. Claims administration service fees are paid to us by third-party insurers for credit default insurance claims adjudication services performed by our subsidiaryInsurance Administrative Services, LLC on its insured servicing portfolio. The administration fee is equal to 3% of the monthly insurance earned premium for as long as the loan remains outstanding.
Cost of services and operating expenses
Cost of services. Cost of services primarily consists of fees paid to third party partners for lead-generation efforts, compensation and benefits expenses relating to employees engaged in lenders' services and claims administration activities, fees paid for actuarial services related to the development of the monthly premium program and fees for integration with loan origination systems of automotive lenders. We generally expect cost of services to increase in absolute dollars as the total number of certified loans continues to grow; however, we expect the cost of services to remain relatively constant in the near to immediate term as a percentage of our program fee revenue. General and administrative expenses. General and administrative expenses are comprised primarily of expenses relating to employee compensation and benefits, non-cash share-based compensation, travel, meals and entertainment expenses, data and software expenses and professional and consulting fees. In the near to intermediate term, we expect general and administrative expenses to remain relatively constant. Selling and marketing expenses. Selling and marketing expenses consist primarily of compensation and benefits of employees engaged in selling and marketing activities. We generally expect selling and marketing expenses to increase in absolute dollars as the total number of certified loans continues to grow in the long term; however, we expect selling and marketing expenses to remain relatively constant in the near to intermediate term as a percentage of program fee revenue. Research and development expenses. Research and development expenses primarily consist of employee compensation and benefits expenses for employees engaged in ongoing research and development of our software technology platform. We generally expect our research and development expenses to increase in absolute dollars as our business continues to grow.
Other income (expenses)
Interest expense. Interest expense primarily includes interest payments and the amortization of deferred financing costs in connection with the issuance of the debt.
Loss on extinguishment of debt. The loss on extinguishment of debt primarily reflects unamortized deferred financing costs, which were written off as part of the refinancing of our term loan maturing in 2027 on
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Operating results
The following table presents our operating results for the three months ended
Three Months Ended March 31,
2022 2021 % Change
($ in thousands)
Revenue
Profit share $ 28,310 $ 27,730 2 %
Program fees 19,726 14,911 32 %
Claims administration and other service fees 2,032 1,367 49 %
Total revenue 50,068 44,008 14 %
Cost of services 4,788 3,362 42 %
Gross profit 45,280 40,646 11 %
Operating expenses
General and administrative 7,482 8,212 (9) %
Selling and marketing 3,733 2,397 56 %
Research and development 1,823 591 208 %
Total operating expenses 13,038 11,200 16 %
Operating income 32,242 29,446 9 %
Interest expense (803) (3,289) (76) %
Interest income 25 84 (70) %
Loss on extinguishment of debt - (8,778) 100 %
Other expense - (131) 100 %
Income before income taxes 31,464 17,332 82 %
Income tax expense 8,310 4,470 86 %
Net income $ 23,154 $ 12,862 80 %
Key Performance Measures
The following table presents the main performance measures for the three months ended
Three Months Ended March 31,
2022 2021 % Change
Certified loans 43,944 33,318 32 %
Single-pay 39,561 28,942 37 %
Monthly-pay 4,383 4,376 - %
Average program fees $ 449 $ 448 - %
Single-pay $ 420 $ 418 - %
Monthly-pay $ 714 $ 648 10 %
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Comparison of the three months ended
Revenue
Three Months Ended March 31,
2022 2021
(in thousands)
Profit share
New certified loan originations $ 25,669 $ 22,656
Change in estimated future revenues 2,641 5,074
Total profit share 28,310 27,730
Program fees 19,726 14,911
Claims administration and other service fees 2,032 1,367
Total revenue $ 50,068 $ 44,008
Total revenue increased by $6.1 million , or 14%, for the three months ended
March 31, 2022 , as compared to the same period in 2021, driven by an increase in
anticipated profit share, program fees and claims administration and other
service fee revenues on new originations and the change in estimated future
revenues on historical vintages. As the loan default rate and severity of losses
continued to be lower than anticipated during the three months ended March 31,
2022 , our estimated profit share on historic business increased.
Profit share revenue increased by $0.6 million , or 2%, during the three months
ended March 31, 2022 , as compared to the same period in 2021. During the three
months ended March 31, 2022 , we recorded $25.7 million in anticipated profit
share associated with 43,944 new certified loans for an average of $584 per loan
as compared to $22.7 million in anticipated profit share associated with 33,318
certified loans for an average of $680 per loan during the three months ended
March 31, 2021 . In addition, during the three months ended March 31, 2022 we
recorded $2.6 million in estimated future profit share on business in historic
vintages, as compared to $5.1 million in estimated future profit share on
historic vintages during the three months ended March 31, 2021 .
Program fees revenue increased by $4.8 million , or 32%, for the three months
ended March 31, 2022 as compared to the same period in 2021. The increase was
driven by a 32% increase in certified loan volumes as compared to the prior year
period.
Revenue from claims administration and other service fees, which primarily
represents 3% of our insurance partners' annual earned premium, increased by
$0.7 million , or 49%, for the three months ended March 31, 2022 as compared to
the same period in the prior year, due to a 28% increase in total earned
premiums and a 32% increase in new loan certifications.
Cost of services, gross profit and gross margin
Three Months Ended March 31,
2022 2021
(in thousands)
Total revenue $ 50,068 $ 44,008
Cost of services 4,788 3,362
Gross profit $ 45,280 $ 40,646
Gross margin 90 % 92 %
Gross profit increased by $4.6 million , or 11%, during the three months ended
March 31, 2022 , as compared to the same period in 2021, driven by an increase in
anticipated profit share, program fees and claims administration and other
service fees revenues on new originations and change in estimated future
revenues based on historical vintages as discussed above.
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Operating expenses, operating income and operating margin
Three Months Ended March 31,
2022 2021
(in thousands)
Total revenue $ 50,068 $ 44,008
Gross profit 45,280 40,646
Operating expenses
General and administrative 7,482
8,212
Selling and marketing 3,733
2,397
Research and development 1,823
591
Total operating expenses 13,038
11,200
Operating income $ 32,242 $ 29,446
Operating margin 64 % 67 %
General and administrative expenses decreased by $0.7 million , or 9%, during the
three months ended March 31, 2022 , as compared to the same period last year,
driven primarily by a decrease in professional and consulting fees, partially
offset by increases in employee compensation and benefits as well as travel
expenses.
Selling and marketing expenses increased by $1.3 million , or 56%, during the
three months ended March 31, 2022 as compared to the prior year period,
primarily due to an increase in employee compensation and commissions costs,
driven by both increased headcounts in sales and account management as well as
increased sales.
Research and development expenses increased by $1.2 million , or 208%, during the
three months ended March 31, 2022 , as compared to the same period in the prior
year, due to increases in headcount and software development costs.
Operating income for the three months ended March 31, 2022 increased by $2.8
million , or 9%, as compared to the prior year period, driven by increases in
program fees and anticipated profit share from new originations and estimated
future underwriting profits on historic business.
Interest charges
During the three months endedMarch 31, 2022 and 2021, interest expense was$0.8 million and$3.3 million , respectively. Interest expense decreased$2.5 million or 76% for the three months endedMarch 31, 2022 , as compared to the three months endedMarch 31, 2021 , as a result of lower borrowing costs and lower outstanding debt balances during 2022.
Income taxes
During the three months endedMarch 31, 2022 and 2021, we recognized income tax expense of$8.3 million and$4.5 million , respectively. The effective tax rate for the three months endedMarch 31, 2022 was 26.5%, as compared to an effective tax rate of 25.8% for the three months endedMarch 31, 2021 . Income tax expense increased$3.8 million or 86% during the three months endedMarch 31, 2022 as compared to the three months endedMarch 31, 2021 , primarily as a result of the 82% increase in income before income taxes as well as the increase in the effective tax rate.
Cash and capital resources
Cash flow and liquidity analysis
We assess liquidity primarily in terms of our ability to generate cash to fund
operating and investing activities. A significant portion of our cash from
operating activities is derived from our profit share arrangements with our
insurance partners, which are subject to judgments and assumptions and is,
therefore, subject to variability. We believe that our existing cash resources
and revolving credit facility will provide sufficient liquidity to fund our
near-term working capital needs. We regularly evaluate alternatives for managing
our capital structure and liquidity profile in consideration of expected cash
flows, growth and operating capital requirements and capital market conditions.
Refer to "Critical Accounting Policies and Estimates" in this Quarterly Report
on Form 10-Q and our Annual Report for a full description of the related
estimates, assumptions, and judgments.
Based on our assessment of the underlying provisions and circumstances of our
contractual obligations, other than the risks that we and other similarly
situated companies face with respect to the condition of the capital markets (as
described in "Risk
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Factors" in our Annual Report), there is no known trend, demand, commitment, event, or uncertainty that is reasonably likely to occur that would have a material adverse effect on our consolidated results of operations, financial condition, or liquidity.
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