Open Lending Corp (LPRO) FY 2022 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes appearing in Item 8. Financial Statements and Supplementary Data. This section of our Annual Report generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. Discussions of 2020 items and year-to-year comparisons between 2021 and 2020 that are not included in this Annual Report can be found in Part II, “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021. The following discussion contains forward-looking statements that reflect our future plans, estimates, beliefs and expected performance. The forward-looking statements are dependent upon events, risks and uncertainties that may be outside our control. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to those factors discussed below and elsewhere in this Annual Report, particularly in Item 1A—Risk Factors and Cautionary Note Regarding Forward-Looking Statements, all of which are difficult to predict. In light of these risks, uncertainties and assumptions, the forward-looking events discussed may not occur. We do not undertake any obligation to publicly update any forward-looking statements except as otherwise required by applicable law.
Business Overview
We are a leading provider of lending enablement and risk analytics to credit unions, regional banks, finance companies and the captive finance companies of automakers. Our customers, collectively referred to herein as automotive lenders, make automotive consumer loans to underserved near-prime and non-prime borrowers by harnessing our risk-based interest rate 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 $18.3 billion in automotive loans, accumulated more than 20 years of proprietary data and developed over two million unique risk profiles. We currently serve 438 active lenders.
We specialize in risk-based pricing and modeling and provide automated decision-technology for automotive lenders throughout the U.S. We target the financing needs of near-prime and non-prime borrowers, or borrowers with a credit bureau score generally 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 who must 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, is a cloud-based automotive lending platform. LPP supports loans made to near-prime and non-prime borrowers and is designed to underwrite default insurance by linking automotive lenders to insurance companies. The platform uses risk-based pricing models which enable automotive lenders to assess the credit risk of a potential borrower using data driven analysis. Our proprietary risk models project loan performance, including expected losses and prepayments in arriving at the optimal rate. With five second decisioning, LPP generates a risk-based, all-inclusive interest rate for a loan that is customized to each automotive lender, reflecting cost of capital, loan servicing and acquisition costs, expected recovery rates and target return on assets. LPP risk models use a proprietary score in assessing and pricing risk on automotive loan applications. This score combines credit bureau data and FCRA compliant alternative consumer data to more effectively assess risk and determine the appropriate insurance premium for any given loan application.
LPP is powered by technology that delivers speed and scalability in providing interest rate decisioning to automotive lenders. It supports the full transaction lifecycle, including credit application, underwriting, real-time insurance approval, settlement, servicing, invoicing of insurance premiums and fees and advance data analytics of automotive lender’s portfolio under the program. Through electronic system integration, our software technology connects us to certain parties in our ecosystem.
A key element of LPP is the unique database that drives risk decisioning using data accumulated for more than 20 years. When a loan is insured at origination, all attributes of the transaction are stored in our database. Through the claims management process, we ultimately obtain loan life performance data on each insured loan. Having granular origination and performance data allows our data scientists and actuaries to constantly evolve and refine risk models, based on actual experience and third-party information sources.
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Executive Overview
We facilitate certified loans, as described below, and have achieved financial success by executing on our strategy of penetrating the near-prime and non-prime automotive loan market and refining our data analysis capabilities.
We facilitated 165,211 and 171,697 certified loans during the years ended December 31, 2022 and 2021, respectively.
Total revenue was $179.6 million and $215.7 million for the years ended December 31, 2022 and 2021, respectively.
Operating income was $97.6 million and $150.3 million for the years ended December 31, 2022 and 2021, respectively.
Net income was $66.6 million and $146.1 million for the years ended December 31, 2022 and 2021, respectively.
Adjusted EBITDA, as defined below, was $105.7 million and $155.0 million for the years ended December 31, 2022 and 2021, respectively. Information regarding use of Adjusted EBITDA, a non-GAAP measure, and a reconciliation of Adjusted EBITDA to net income, the most comparable GAAP measure, is included in “Non-GAAP Financial Measures.”
Highlights
The table below summarizes the total dollar-value of insured loans we facilitated and the number of new contracts we signed with automotive lenders for the years ended December 31, 2022 and 2021:
| Year ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2022 | 2021 | |||||
| Certified loans | 165,211 | 171,697 | ||||
| Value of insured loans facilitated (in thousands) | $ | 4,758,597 | $ | 4,331,508 | ||
| Average loan size per certified loans | $ | 28,803 | $ | 25,228 | ||
| Number of contracts signed with automotive lenders | 72 | 71 |
Historically, we have defined “active lenders” as lenders who certify at least one loan during the preceding 12 months. As of December 31, 2022 and 2021, we had 438 and 396 active lenders, respectively. The table below represents lender count information for lenders with certified loan activity during the periods indicated.
| Year ended December 31, | ||||
|---|---|---|---|---|
| 2022 | 2021 | |||
| Lenders certifying loans at the beginning of the period | 396 | 354 | ||
| New lenders (1) | 63 | 60 | ||
| Net change in lenders (2) | (21) | (18) | ||
| Lenders certifying loans at the end of the period | 438 | 396 |
(1) New lenders using LPP to certify loans for the first time during the period.
(2) Net change in the number of lenders previously onboarded and using LPP to certify loans during the period. Certain lenders experience periods of inactivity followed by periods of activity, causing the lender count to fluctuate from period to period.
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 us, with recurring revenue streams.
Certified 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 certified loans in that period.
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Underwriting Profit
We define “underwriting profit” as the total underwriting profit expected to be received by insurers over the expected life of the insured loans.
Earned Premium
We define “earned premium” as the total insurance premium earned by insurers in a given period. Earned premiums were $294.0 million and $223.3 million, respectively, for the years ended December 31, 2022 and 2021, respectively.
Recent Developments
Insurance Carrier Partners
On May 2, 2022, we signed a program management agreement with Arch Specialty Insurance Company, a part of Arch Capital Group Ltd., who provides credit default insurance policies for LPP, from which we earn profit share revenue and claims administration fees.
On January 24, 2023, CNA, one of our insurance carriers, informed us of their intent not to renew their producer and claims service agreements with us when they expire on December 31, 2023. CNA will continue to provide auto loan default insurance policies for LPP certified loans until the terms of their producer and claims service agreements expire on December 31, 2023, unless mutual agreements with CNA are reached to transition new originations to our other insurance carriers prior to December 31, 2023. In addition, CNA will continue to service and provide claim funding for any of its existing default insurance policies for the remaining life of the loans associated with such policies. During the period until the expiration of these agreements, we expect to transition our customers that use CNA to our other insurance carriers.
See “Item 1A—Risk Factors—Risks Related to Our Business—If we lose one or more of our insurance carriers and are unable to replace their commitments, it could have a material adverse effect on our business.”
2022 Credit Agreement
On September 9, 2022, we entered into a first amendment to our existing credit agreement with Wells Fargo Bank, N.A., as the administrative agent, and the financial institutions party thereto, as the lenders (the “First Amendment”). The First Amendment provided us senior secured Credit Facilities in an aggregate principal amount of $300.0 million by (i) establishing a new senior secured term loan facility in an aggregate principal amount of $150.0 million (the “New Term Loan due 2027”) and (ii) increasing the aggregate principal amount of commitments to $150.0 million (the “New Revolving Credit Facility”), both maturing on September 9, 2027 (collectively, the “2022 Credit Agreement”). Refer to Note 5—Debt for further discussion on our 2022 Credit Agreement.
Share Repurchase Program
On November 17, 2022, our Board of Directors authorized the Share Repurchase Program for up to $75.0 million of our outstanding common stock, which enables us to repurchase shares of our common stock through November 17, 2023. Repurchases may be made at management’s discretion from time to time on the open market. The Share Repurchase Program may be suspended, amended, or discontinued at any time. Refer to Note 7—Stockholders’ Equity for further discussion on our Share Repurchase Program activity during the year.
Key Factors Affecting Operating Results
Our future operating results and cash flows are dependent upon a number of opportunities, challenges and other factors, including the growth in the number of financial institutions and transaction volume, competition, profit share assumptions and industry trends and general economic conditions. Key factors affecting our operating results include the following:
Growth in the Number of Financial Institutions
The growth trend in active automotive lenders using LPP is a critical variable directly affecting revenue and financial results. It influences the number of loans funded on LPP and as such, the fees we earn and the cost of the services we provide. Growth in our active automotive lender relationships will depend on our ability to retain existing as well as add new automotive lenders.
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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. 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, is a unique solution for which we have not identified 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.
Profit Share 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 historic 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. Please refer to Critical Accounting Policies and Estimates for more information on these assumptions.
Industry Trends and General Economic Conditions
Our results of operations 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 inflation, rising 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.
On August 16, 2022, the U.S. government enacted the Inflation Reduction Act of 2022 (the “IR Act”) which includes, among other provisions, changes to the U.S. corporate income tax system, including a 15% minimum tax based on “adjusted financial statement income” exceeding $1 billion and a 1% excise tax on net repurchases of stock after December 31, 2022. The IR Act may impact the cost efficiency of the Share Repurchase Program.
Concentration
Our three largest insurance partners accounted for 34%, 11% and 10%, respectively, of our total revenue during the year ended December 31, 2022. Our two largest insurance partners accounted for 41% and 22%, respectively, of our total revenue during the year ended December 31, 2021. Termination or disruption of these relationships could materially and adversely impact our revenue. See “Item 1A—Risk Factors—Risks Related to Our Business—If we lose one or more of our insurance carriers and are unable to replace their commitments, it could have a material adverse effect on our business.”
Basis of Presentation
We conduct business through one operating segment and we operate in one geographic region, the U.S. Refer to Note 2—Summary of Significant Accounting and Reporting Policies of the accompanying consolidated financial statements for more information.
Components of Results of Operations
Total Revenue
Our revenue is generated through three streams: (i) profit share paid to us by insurance partners, (ii) program fees paid to us by automotive 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 automotive lenders with credit default insurance on loans those 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 expenses and losses (including reserves for incurred, but not reported losses), with losses accrued and carried forward for future profit share calculations.
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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 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. Fees are either capped at $600 per loan or calculated as a percentage of the funded loan amount. For monthly-pay loans, the fee paid by the lender is 3% of the initial 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 subsidiary, IAS, 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 automotive 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 the loan origination system of automotive lenders and fees paid to credit bureaus and data service providers for credit applicant data. In the near term, we generally expect cost of services to increase as a percentage of our program fee revenue as we continue to grow our third-party partner relationships and expand our employee support team.
General and administrative expenses. General and administrative expenses are comprised primarily of expenses relating to corporate-level 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 term, we expect general and administrative expenses to increase as a result of our headcount growth.
Selling and marketing expenses. Selling and marketing expenses consist primarily of compensation and benefits expenses of employees engaged in selling and marketing activities. We generally expect selling and marketing expenses to increase as a percentage of our program fee revenue in the near term as we continue to expand our sales and marketing team.
Research and development expenses. Research and development expenses consist primarily 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 costs to decrease in absolute dollars as the near-term focus shifts to internal software development projects.
Other Income (Expense)
Interest expense. Interest expense primarily includes interest payments and the amortization of deferred financing costs in connection with the issuance of our debt.
Interest income. Interest income primarily includes interest earned on money market funds and U.S. Treasury securities.
Gain on extinguishment of tax receivable agreement. Gain on extinguishment of tax receivable agreement (“TRA”) reflects gain recognized upon the early termination of our TRA with our Predecessor and affiliates in 2021.
Loss on extinguishment of debt. Loss on extinguishment of debt primarily reflects unamortized deferred financing costs, which were written off in connection with the refinancing of our Term Loan due 2027 on March 19, 2021.
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Results of Operations
The following table sets forth our results of operations for the years ended December 31, 2022 and 2021:
| Year Ended December 31, | |||||||
|---|---|---|---|---|---|---|---|
| 2022 | 2021 | % Change | |||||
| ($ in thousands) | |||||||
| Revenue | |||||||
| Profit share | $ | 90,056 | $ | 133,215 | (32)% | ||
| Program fees | 80,611 | 75,630 | 7% | ||||
| Claims administration and other service fees | 8,927 | 6,810 | 31% | ||||
| Total revenue | 179,594 | 215,655 | (17)% | ||||
| Cost of services | 19,968 | 18,621 | 7% | ||||
| Gross profit | 159,626 | 197,034 | (19)% | ||||
| Operating expenses | |||||||
| General and administrative | 35,950 | 30,393 | 18% | ||||
| Selling and marketing | 17,856 | 12,000 | 49% | ||||
| Research and development | 8,205 | 4,352 | 89% | ||||
| Total operating expenses | 62,011 | 46,745 | 33% | ||||
| Operating income | 97,615 | 150,289 | (35)% | ||||
| Interest expense | (5,832) | (5,859) | —% | ||||
| Interest income | 1,995 | 213 | 837% | ||||
| Gain on extinguishment of tax receivable agreement | — | 55,422 | (100)% | ||||
| Loss on extinguishment of debt | — | (8,778) | (100)% | ||||
| Other expense, net | (238) | (119) | 100% | ||||
| Income before income taxes | 93,540 | 191,168 | (51)% | ||||
| Income tax expense | 26,920 | 45,086 | (40)% | ||||
| Net income | $ | 66,620 | $ | 146,082 | (54)% |
Key Performance Measures
The following table sets forth key performance measures for the years ended December 31, 2022 and 2021:
| Year Ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | % Change | ||||||||
| Certified loans | 165,211 | 171,697 | (4) | % | ||||||
| Single-pay | 144,959 | 152,629 | (5) | % | ||||||
| Monthly-pay | 20,252 | 19,068 | 6 | % | ||||||
| Average program fees | $ | 488 | $ | 440 | 11 | % | ||||
| Single-pay | $ | 450 | $ | 412 | 9 | % | ||||
| Monthly-pay | $ | 772 | $ | 670 | 15 | % |
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Comparison of Year Ended December 31, 2022 and 2021
Revenue
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2022 | 2021 | |||||
| ($ in thousands) | ||||||
| Profit share | ||||||
| New certified loan originations | $ | 95,733 | $ | 102,324 | ||
| Change in estimated future revenues | (5,677) | 30,891 | ||||
| Total profit share | 90,056 | 133,215 | ||||
| Program fees | 80,611 | 75,630 | ||||
| Claims administration and other service fees | 8,927 | 6,810 | ||||
| Total revenue | $ | 179,594 | $ | 215,655 |
Total revenue decreased by $36.1 million, or 17%, for the year ended December 31, 2022 as compared to the year ended December 31, 2021, driven by a $43.2 million decrease in profit share revenue, which was partially offset by increased program fee and claims administration fee revenues of $5.0 million and $2.1 million respectively, as compared to the year ended December 31, 2021.
Profit share revenue decreased by $43.2 million, or 32%, for the year ended December 31, 2022 as compared to the year ended December 31, 2021. During the year ended December 31, 2022, we recorded $95.7 million in anticipated profit share associated with 165,211 certified loans for an average of $579 per loan, as compared to $102.3 million in anticipated profit share associated with 171,697 certified loans for an average of $596 per loan during the year ended December 31, 2021.
In addition, during the year ended December 31, 2022, we recorded a $5.7 million reduction in estimated future profit share revenues related to business in historic vintages primarily as a result of higher than anticipated prepayment rates, partially offset by lower loan default rates and severity of losses. During the year ended December 31, 2021, we recorded a $30.9 million increase in estimated future profit share revenues on certified loans originated in historic vintages primarily due to lower than anticipated prepayment rates, loan default rates and severity of losses.
Program fees revenue increased $5.0 million, or 7%, for the year ended December 31, 2022 as compared to the year ended December 31, 2021. This increase in program fees revenue was driven by an 11% increase in unit economics per certified loan, partially offset by a 4% decrease in certified loan volume, as compared to the year ended December 31, 2021.
Revenue from claims administration and other service fees, which primarily represents 3% of our insurance partners’ annual earned premium, increased $2.1 million, or 31%, for the year ended December 31, 2022 as compared to the year ended December 31, 2021, due to a 32% increase in total earned premiums.
Cost of Services, Gross Profit and Gross Margin
| Year Ended December 31, | |||||
|---|---|---|---|---|---|
| 2022 | 2021 | ||||
| ($ in thousands) | |||||
| Revenue | $ | 179,594 | $ | 215,655 | |
| Cost of services | 19,968 | 18,621 | |||
| Gross profit | $ | 159,626 | $ | 197,034 | |
| Gross margin | 89 | % | 91 | % |
Cost of services increased $1.3 million, or 7% during the year ended December 31, 2022, as compared to the year ended December 31, 2021, primarily due to increased fees of $1.8 million paid to third party partners for lead-generation efforts and higher employee compensation and benefit costs of $1.0 million associated with the growth of our implementation and claims
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administration operations, both partially offset by one-time costs associated with customer implementation efforts of $1.5 million incurred during the year ended December 31, 2021.
Gross profit decreased by $37.4 million, or 19%, for the year ended December 31, 2022 as compared to the year ended December 31, 2021, primarily driven by a decrease in anticipated profit share on historic vintages partially offset by increases in both program fees and claims administration service fees, as discussed above.
Operating Expenses, Operating Income and Operating Margin
| Year Ended December 31, | |||||
|---|---|---|---|---|---|
| 2022 | 2021 | ||||
| ($ in thousands) | |||||
| Revenue | $ | 179,594 | $ | 215,655 | |
| Gross profit | 159,626 | 197,034 | |||
| Operating expenses | |||||
| General and administrative | 35,950 | 30,393 | |||
| Selling and marketing | 17,856 | 12,000 | |||
| Research and development | 8,205 | 4,352 | |||
| $ | 62,011 | $ | 46,745 | ||
| Operating income | $ | 97,615 | $ | 150,289 | |
| Operating margin | 54 | % | 70 | % |
General and administrative expenses increased by $5.6 million, or 18%, for the year ended December 31, 2022 as compared to the year ended December 31, 2021, primarily driven by higher corporate employee compensation and benefit costs of $5.3 million.
Selling and marketing expenses increased by $5.9 million, or 49%, for the year ended December 31, 2022 as compared to the year ended December 31, 2021, primarily driven by increases in employee compensation and benefit costs of $3.5 million, as well as increases in expenses related to travel, marketing and business development of $1.6 million associated with increased levels of business activity.
Research and development expenses increased by $3.9 million, or 89%, for the year ended December 31, 2022 as compared to the year ended December 31, 2021, primarily due to increases in employee compensation and benefit costs and other services associated with our investment in research and development technology of $5.1 million.
Operating income for the year ended December 31, 2022, decreased by $52.7 million, or 35%, as compared to the year ended December 31, 2021, primarily driven by decreased estimated profit share on historic vintages, as well as increases in operating expenses related to general and administrative, selling and marketing, and research and development, as discussed above.
Income Taxes
During the years ended December 31, 2022 and 2021, we recognized income tax expense of $26.9 million and $45.1 million, respectively. The effective tax rate for the year ended December 31, 2022 was 28.8%, as compared to an effective tax rate of 23.6% for the year ended December 31, 2021. Income tax expense decreased $18.2 million, or 40% during the year ended December 31, 2022 as compared to the year ended December 31, 2021, primarily as a result of a decrease in income before income taxes. Refer to Note 14 – Income Taxes for further discussion.
Liquidity and Capital Resources
Our principal liquidity requirements are to (i) meet working capital, tax and capital expenditure needs, (ii) service and repay our indebtedness and (iii) repurchase shares of our common stock.
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
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operating capital requirements and capital market conditions. Refer to Critical Accounting Policies and Estimates and Item 1A — Risk Factors 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 Item 1A—Risk Factors), 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.
The following table provides a summary of cash flow data:
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2022 | 2021 | |||||
| (in thousands) | ||||||
| Net cash provided by operating activities | $ | 107,431 | $ | 95,156 | ||
| Net cash used in investing activities | $ | (624) | $ | (1,987) | ||
| Net cash used in financing activities | $ | (17,797) | $ | (77,808) |
Cash Flows from Operating Activities
Our cash flows provided by operating activities reflect net income adjusted for certain non-cash items and changes in operating assets and liabilities.
The following table summarizes the adjustments in the operating activities in the statement of cash flows:
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2022 | 2021 | |||||
| ($ in thousands) | ||||||
| Net income | $ | 66,620 | $ | 146,082 | ||
| Deferred income taxes and other non-cash expenses | 7,742 | 25,536 | ||||
| Non-cash gain, net | — | (46,644) | ||||
| Change in contract assets | 37,527 | (23,763) | ||||
| Change in other assets and liabilities | (4,458) | (6,055) | ||||
| Net cash provided by operating activities | $ | 107,431 | $ | 95,156 |
Net cash provided by operating activities increased by $12.3 million for the year ended December 31, 2022 as compared to the year ended December 31, 2021. The increase was primarily attributable to increased cash collections of $28.2 million related to profit share, program fees and claims administration service fee revenues and a $1.7 million reduction in interest payments. This increase was offset by increased cash payments related to cost of services and operating expenses of $8.3 million and income tax payments of $10.8 million during the year ended December 31, 2022 as compared to the year ended December 31, 2021.
Cash Flows from Investing Activities
For the years ended December 31, 2022 and 2021, net cash used in investing activities was $0.6 million and $2.0 million, respectively. For the years ended December 31, 2022 and 2021, the investments primarily related to software developed for internal use.
Cash Flows from Financing Activities.
Our cash flows used in financing activities primarily consist of proceeds from debt, payments of debt and deferred financing costs, and shares repurchased.
For the year ended December 31, 2022, net cash used in financing activities was $17.8 million. The cash inflow of $150.0 million relates to proceeds from our New Term Loan due 2027, which paid off our existing debt as of that date, less $1.0 million in deferred financing costs associated with the loan. Debt principal payments were $123.6 million, primarily related to payment in full of the Term Loan due 2026. In addition, we paid off all amounts outstanding under the 2021 Revolving Credit
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Facility (as defined hereinafter) totaling $25.0 million and repurchased 2,643,306 shares of our common stock held in treasury stock for a total of $18.0 million.
For the year ended December 31, 2021, net cash used in financing activities was $77.8 million. The cash used primarily consisted of $36.9 million in early termination and settlement of the TRA with our Predecessor and affiliates, $20.0 million related to our repurchase of 612,745 shares of our common stock held in treasury stock and debt principal payments of $169.2 million, primarily related to the payment in full of the Term Loan due 2027 in March 2021. In addition, we paid down the 2021 Revolving Credit Facility by $25.0 million. The cash inflow relates to $175.0 million in proceeds associated with the 2021 Credit Agreement (as defined hereinafter), which refinanced our existing debt as of that date, less $1.7 million in deferred financing costs associated with this facility.
Debt
As of December 31, 2022, we had no amounts outstanding under our New Revolving Credit Facility and $149.1 million outstanding under our New Term Loan due 2027.
Share Repurchase Program
On November 17, 2022, the Board of Directors authorized the Share Repurchase Program allowing the Company to repurchase up to $75.0 million of the Company’s outstanding common stock until November 17, 2023. Repurchases may be made at management’s discretion from time to time on the open market. The Share Repurchase Program may be suspended, amended, or discontinued at any time. Pursuant to the Share Repurchase Program, the Company repurchased 2,643,306 shares at an average price of $6.80 for a total of $18.0 million during the year ended December 31, 2022, leaving $57.0 million available under our current Share Repurchase Program as of December 31, 2022. These shares were recorded to treasury stock at cost.
Non-GAAP Financial Measures
Adjusted EBITDA
Adjusted EBITDA is a non-GAAP financial measure used by management to evaluate its operating performance, generate future operating plans, and make strategic decisions, including those relating to operating expenses and the allocation of internal resources. Accordingly, we believe this measure provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and Board of Directors. This measure further provides useful analysis of period-to-period comparisons of our business, as it excludes the effect of certain non-cash items and certain variable charges. Adjusted EBITDA is defined as GAAP net income, excluding interest expense, income taxes, depreciation and amortization expense of property and equipment, share-based compensation expense, gain on extinguishment of the TRA, and loss on extinguishment of debt. Adjusted EBITDA margin is defined as Adjusted EBITDA expressed as a percentage of total revenue.
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The following table presents a reconciliation of GAAP net income (loss) to Adjusted EBITDA for each of the periods indicated:
| Year Ended December 31, | |||||
|---|---|---|---|---|---|
| 2022 | 2021 | ||||
| ($ in thousands) | |||||
| Net income | $ | 66,620 | $ | 146,082 | |
| Non-GAAP adjustments: | |||||
| Interest expense | 5,832 | 5,859 | |||
| Income tax expense | 26,920 | 45,086 | |||
| Depreciation and amortization expense | 915 | 792 | |||
| Share-based compensation expense | 5,449 | 3,815 | |||
| Gain on extinguishment of tax receivable agreement | — | (55,422) | |||
| Loss on extinguishment of debt | — | 8,778 | |||
| Total adjustments | 39,116 | 8,908 | |||
| Adjusted EBITDA | $ | 105,736 | $ | 154,990 | |
| Total revenue | $ | 179,594 | $ | 215,655 | |
| Adjusted EBITDA margin | 59 | % | 72 | % |
For the year ended December 31, 2022, Adjusted EBITDA decreased by $49.3 million, or 32%, as compared to year ended December 31, 2021. The decrease in Adjusted EBITDA during the year ended December 31, 2022 reflects the decrease in operating income primarily driven by the decrease in estimated future revenues on historic vintages and increased operating expenses.
Critical Accounting Policies and Estimates
In preparing our consolidated financial statements, we make assumptions, judgments and estimates that can have a significant impact on our revenue, income (loss) from operations and net income (loss), as well as on the value of certain assets and liabilities on our consolidated balance sheets. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions.
The consolidated financial statements have been prepared in accordance with GAAP. To prepare these financial statements, we make estimates, assumption, and judgments that affect what we report as our assets and liabilities, what we disclose as contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expenses during the periods presented.
In accordance with our policies, we regularly evaluate our estimates, assumptions, and judgments, including, but not limited to, those concerning revenue recognition, depreciation and amortization, contingencies, share-based compensation, and income taxes, and base our estimates, assumptions, and judgments on historical experience and on factors we believe reasonable under the circumstances. The results involve judgments about the carrying values of assets and liabilities not readily apparent from other sources. If our assumptions or conditions change, the actual results we report may differ from these estimates. We believe the following critical accounting policies affect the more significant estimates, assumptions, and judgments we use to prepare these consolidated financial statements. Refer to Note 2—Summary of Significant Accounting and Reporting Policies in the accompanying consolidated financial statements for a summary of our significant accounting policies.
Profit Share Revenue Recognition
We recognize revenue in accordance with the Financial Accounting Standards Board’s Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers (“ASC 606”). Application of ASC 606 requires us to make judgments and estimates related to the classification, measurement and recognition of revenue. Our revenue primarily consists of profit share, program fees derived from contracts with lending institutions and claims administration service fees from contracts with insurance carriers and is recognized when the contractual performance obligation is satisfied.
The primary judgment relating to the recognition of revenue is the estimation of our profit share with our insurance partners. On a quarterly basis, we use a forecast model to project loan-level earned premiums and insurance claim payments. Our forecasts are driven by our projections of prepayment rate, loan default rate and severity of loss. These forecast assumptions are derived
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from an analysis of the historical performance of the active loan portfolio, prevailing default and prepayment trends, and macroeconomic projections. To the extent these forecast assumptions change, our profit share revenue will be adjusted.
We continually assess the default and prepayment assumptions of our core forecast model against reported performance and lender delinquency data. We make updates to the forecast model to ensure that default and prepayment rate projections align with actual experience.
We evaluate our forecast assumptions for prepayment rate, loan default rate and default severity of loss by performing a sensitivity analysis calculating the impact on profit share revenue of a hypothetical 10% increase and decrease in each assumption. The below table summarizes the results of the sensitivity analysis as of December 31, 2022:
| Prepayment rate | Loan default rate | Default severity of loss | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Assumption change | 10 | % | (10) | % | 10 | % | (10) | % | 10 | % | (10) | % | |||||
| Impact on revenue | (3) | % | 3 | % | (6) | % | 6 | % | (7) | % | 7 | % |
Income Taxes
Prior to closing of the Business Combination, Open Lending, LLC, the sole owner of Lenders Protection and Open Lending Services, Inc., was treated as a partnership for income tax purposes. Therefore, no provision had historically been made for income tax purposes prior to the closing.
Subsequent to closing, Open Lending, LLC became a disregarded entity, wholly owned by us through its wholly owned subsidiaries. As of the close of the Business Combination, we are subject to income tax on a consolidated basis.
Our effective tax rate is based on income at statutory tax rates, adjusted for non-taxable and non-deductible items and tax credits. Management’s best estimate of future events and their impact is included in our effective tax rate. Certain changes or future events, such as changes in tax legislation, could have an impact on our estimates and effective tax rate. Audit periods remain open for review until the statute of limitations has passed.
The calculation of income taxes involves estimating the actual current tax liability together with assessing temporary differences in recognition of income (loss) for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheets. We record a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. In assessing the need for a valuation allowance, we are required to develop estimates of the anticipated timing of the reversal of existing deferred tax liabilities, as well as estimates of future taxable income in some instances. Judgment is inherent in this process and differences between the estimated and actual amounts could result in a material impact on our consolidated financial statements.
We recognize liabilities for uncertain tax positions based on a two-step process. The first step requires us to determine whether the weight of available evidence indicates that the tax position has met the threshold for recognition. Therefore, we must evaluate whether it is more likely than not that the position will be sustained on audit, including resolution of any related appeals or litigation processes. The second step requires us to measure the tax benefit of the tax position taken, or expected to be taken, in an income tax return as the largest amount that is more than 50% likely of being realized upon ultimate settlement. This measurement step is inherently complex and requires subjective estimations of such amounts to determine the probability of various possible outcomes. We re-evaluate the uncertain tax positions each quarter based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, expirations of statutes of limitation, effectively settled issues under audit, and new audit activity. Such a change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision in the period.
Share-Based Compensation Awards
We measure and recognize compensation expense for all share-based awards made to employees and non-employee directors based on estimated fair values on the date of grant. To determine the fair value of the share-based awards, we use the closing price of our common stock publicly traded on the Nasdaq on the date of grant for time-based and performance-based restricted stock awards, and we utilize the Black-Scholes option pricing model to value stock options, which involves inputs for the share value of Open Lending, expected share volatility, expected term of the awards, risk-free interest rate and expected dividend. The expected volatility was based on the average of implied and observed historical volatility of comparable companies as we do not have enough history as a public company. The determination of fair value is affected by assumptions regarding a number of highly complex and subjective variables. Changes in the subjective assumptions can materially affect the estimate of their fair value.
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The compensation expense is recognized on a straight-line basis over the requisite service or performance period. Performance-based restricted units (“PSUs”) are evaluated on a quarterly basis for probability of meeting performance metrics and any adjustments to share-based compensation expense are then made in the quarter of evaluation. Forfeitures are recognized as occurred.
For PSUs, we make assumptions regarding the likelihood of achieving performance metrics. If actual results differ significantly from these estimates, share-based compensation expense and our results of operations could be materially affected. Refer to Note 8—Share-Based Compensation of the accompanying consolidated financial statements for more information.
Recent Accounting Pronouncements
Refer to Note 2—Summary of Significant Accounting and Reporting Policies to the accompanying consolidated financial statements for our discussion about new accounting pronouncements adopted and those pending.
Contractual Obligations
As of December 31, 2022, our estimated future obligations include both current and long-term obligations. For our debt described in Note 5—Debt, we have a current obligation of $3.8 million and a long-term obligation of $145.3 million. Under our operating lease described in Note 11—Commitments and Contingencies, we have a current obligation of $0.6 million and a long-term obligation of $4.1 million.