Earlypay Limited (EPY) Earnings Call Transcript & Summary

[Audio Gap] Thursday, the 22nd of February 2024. I am pleased to welcome Earlypay's management team, James Beeson and Paul Murray, who will be today's presenters. Just a bit of housekeeping before we kick off. There will be a Q&A session at the end of the formal presentation. [Operator Instructions] I will now hand over to James to commence his presentation. Thank you.

Thanks, Grace, and welcome, everyone, to Earlypay's first half results for the 6 months ending 31 December 2023. I'm also joined today by our CFO, Paul Murray. Shortly, I'll take you through a presentation of our results, which will then be followed by Q&A, as Grace mentioned. The first slide shows our reported results for the first half. I'll cover more of the detail on future slides, but the high-level takeaways are: average Funds in Use was down 18% on the prior period, which corresponds to reported net revenue also reducing by the same percentage to $18.2 million. Credit impairment expense was materially lower at $900,000 compared to $14.1 million in the prior period. The prior period included significant impairment costs, mostly relating to our major client RevRoof which went into administration in late 2022. Reported net profit after tax or NPAT returned to a positive $2.0 million, which includes some nonrecurring expenses relating to the RevRoof recovery and Timelio transaction costs. When we add back these nonrecurring items, the underlying pro forma NPAT was $2.9 million. Reported earnings per share was $0.07 in the half, and the Board intends to reinstate the full year dividend in financial year '24 as we continue to rebuild retained earnings. Moving to the operational highlights. We have completed several key milestones over the past 6 months that continue to strengthen the foundations of the business for future sustainable growth. In December, we announced the resolution of the RevRoof recovery process, which resulted in us receiving around $8.4 million of cash from the sale proceeds of the business which had until then been held in trust pending the finalization of a legal dispute. In total, Earlypay incurred a credit loss of $10.5 million and recovery-related expenses of another $4.7 million. There were many lessons that we had from this disappointing experience, and they have been and continue to be applied to improving all aspects of the business, including our practices around underwriting, documentation, settlements, client management and risk management. In November, we completed the acquisition of selected assets from Timelio, a specialist invoice and trade finance provider that provided us with an additional $33 million of Invoice Finance and $5 million of trade finance Funds in Use, which has helped offset albeit not entirely some of the lost Funds in Use from RevRoof and other clients. Additionally, as part of the transaction, we brought across several highly capable staff who are already adding significant value at Earlypay. Recently, we also settled on our new invoice and trade finance facility with a $220 million senior limit provided by 1 of the big 4 banks, extending our existing and long-term partnership with them. This new warehouse brings material operational benefits and will reduce our cost of funding by around 1% across our invoice and trade book when fully utilized. It also releases a considerable amount of cash from the previous arrangement, which I'll touch on later. The refinancing of the Equipment Finance facility is under review given the limited financial benefits it will deliver. Presenting on this slide is our pro forma first half financials for financial year '24, which removes the impact of RevRoof. For a breakdown of the adjustments made to get from reported earnings to pro forma earnings, shareholders can refer to the Appendix section of this results presentation, which has been lodged with the ASX. Pro forma average Funds In Use was down 15%, reflective of our more cautious risk appetite for new business given the difficult economic environment for SMEs. We also actively exited some facilities that did not meet our revised risk appetite and have a larger-than-normal level of client attrition in our Invoice Finance client base due to financial stress. Funds In Use for Equipment Finance also fell by $29 million due to lower originations, which contributed to the overall drop in Funds in Use. Although it was late in the half, the addition of the Timelio portfolio helped offset the Funds in Use decline and the credit portfolio -- the credit quality of that portfolio was generally strong, albeit at tighter margins than the existing Earlypay portfolio. Net revenue broadly fell in line with Funds in Use and credit impairment expenses improved materially compared to the prior period. Underlying pro forma NPAT increased 76% to $2.9 million, providing a strong foundation to build upon in future periods. Looking at the invoice and trade finance products segment. As I've already spoken about, we saw a decline in our average Funds in Use, which is one of the main drivers of net revenue along -- net revenue performance along with net revenue margin. Our net interest margin decreased to 5.3%, primarily driven by the previous trade finance warehouse not being fully deployed into income-generating loans. It's worthwhile highlighting the part of the decline in admin fees other than that the general [ pool ] in Funds in Use is due to a single large client being onboarded and exited within the first half of 2023, which also contributed around $9 million to the average Funds in Use during that period. The Timelio portfolio, which was included in mid-November, also started to put downward pressure on admin fees. As although net interest margin is similar to the Earlypay portfolio, admin fees are much lower for Timelio clients. There was a small write-back of the credit provision of around $300,000, mostly due to lower Funds in Use, and this was a significant improvement on the $4.2 million expense in the prior period. Given the lower net revenue generated by the Invoice Finance segment, managing OpEx lower is a key focus of the management team. The Equipment Finance portfolio fell by around 20% as new originations were modest in the half, partially due to managing the asset mix of the pool to comply with portfolio parameters. Around a week ago, on the 13th of February, we [ attrit ] a portfolio parameter relating to a specific asset class and are in discussions with the lenders to remedy this breach, and we expect this to be resolved soon. Net revenue was lower due to the smaller book size and lower early repayment fees due to less borrowers refinancing their loans given the economic conditions and higher current market rates. Credit impairment expense was higher at $1.2 million, although this is not expected to be recurring. Greater than 30-day arrears remains low at around 60 basis points. Our balance sheet remains robust with more than $56 million of cash at 31 December 2023. Although it should be noted that this cash balance is at an exact point in time and can vary widely intra month, particularly in December where there is generally a large amount of cash received at the very end of the month, which increases the cash balance and lowers the receivables balance. As of the 31st of December, there was approximately $13 million of restricted cash held in trust for the warehouse facilities. The allowance for expected credit losses for Invoice Finance fell mostly due to those exposures being written off. Intangible assets increased by $3.7 million, which represents the $3 million purchase price, some of Timelio and also some ECL provisions and transaction costs. This has booked as customer relationships and intangibles, which will be amortized over the next 2.5 years. And none of that went to group wallet to [ allow ] customer relationships. Net tangible assets decreased slightly but still remained strong at around $43 million, which is around $0.148 of NTA per share. Although it was a little delayed, I'm pleased to say that our new $220 million Invoice and Trade Finance facility has now closed, with the Invoice and Trade portfolios being funded on the 22nd of January and 14th of February, respectively. We expect to achieve an overall interest rate saving of around 1% compared to the previous facilities when this facility is fully utilized. The new facility greatly simplified our treasury function by funding both Invoice and Trade and releases a material amount of cash that was previously required to manage [indiscernible] volatility and receivables and Funds in Use. There is plenty of headroom in the warehouse at the moment, but there is flexibility to create the facility to grow -- to accommodate future organic and potentially inorganic growth. Instead of issuing a mezzanine tranche in the new facility to an external funder, we chose to notionally use part of the corporate bond to fund them as [ layer ] given its flexibility, the marginal cost saving of issuing mezz and also the transaction costs associated with conserving the new mezzanine provider. The warehouse structure also allow [Audio Gap] at a later stage if we chose to. The smaller EF facility was also eventually closed and those Equipment Finance assets were moved into the main warehouse. We are initially looking at refinancing the main Equipment Finance facility, but that has been closed for now given the minimal financial benefits and the transaction costs of setting up in new one. Instead, we will likely continue with the existing funders, although we're in discussion to adjust some full parameters to have more flexibility around the main assets we are originally [ have ]. Throughout the first half, our Funds in Use reduced as a result of 2 key reasons. Several Invoice Finance clients being exited due to no longer meeting our internal risk assessment criteria; and secondly, natural accretion -- natural clients [Audio Gap] the revenue margins were not equivalent. The Timelio portfolio is generally a high-quality book of clients. And as a result, the margins we charge are lower than the clients that we lost from the Earlypay book throughout the first half. Therefore, whilst the Funds in Use may have largely been offset, our overall revenue margin will fall. As a result of this, a lot of the interest rate savings from the new warehouse will be offset by margin compression in the short term. Overtime loan margins are expected to widen again as we had Funds in Use with our typical client base. For the remainder of the financial year '24, we are targeting a resumption of sustainable growth in Invoice Financing to take advantage of the strong demand for our core product. We're very focused on increasing the conversion of leads by improving how we deliver Invoice Finance to SMEs and their referrers to make it an easier product to access. Our confidence in achieving sustainable growth is further underpinned by the improved technology capability from the Timelio acquisition, which is driving improvements in client and referrer experience, which is helping with retention and also new business acquisition. The enhanced tech capability from the Timelio team also allows us to pursue new business opportunities for invoice financing through embedded finance and platform integrations that we haven't been able -- haven't been equipped to do in the past. The new warehouse provides interest cost savings and additional flexibility to grow, and increased automation and streamlined processes will be critical in driving OpEx reductions over the short and medium term. We are reaffirming our guidance from the AGM being that financial year '24 underlying pro forma NPAT is expected to exceed financial year '23 underlying pro forma NPAT of $4.8 million. It's important to note that this guidance includes only minimal upside from the following: Growth in Funds in Use for the Invoice Finance book, which as I touched on earlier, has been subdued recently, but we have no shortage of demand should we start to see an improvement in the economic outlook. Second point is net revenue margin expansion. And thirdly, we'll be looking to significant -- some significant gains in OpEx. On capital management, following the acquisition of Timelio and the new warehouse refinancing, we expect to have around $10 million of cash available for corporate -- for capital management initiatives. Remember [Audio Gap] invoice and trade warehouse to an external investor and the state chose to notionally fund it by using part of the corporate bond that we already have. The Board continues to consider EPS accretive initiatives, which may include additional bolt-on acquisitions to augment our organic growth aspirations, repaying some of the corporate bond and/or repurchasing shares through the buyback. Additionally, the Board remains committed in its intention to reinstate the ordinary dividend in financial year '24 as retained earnings are rebuilt. In closing, I'd like to say that after a volatile period, we are now confident that the foundations are in place to resume a sustainable growth path led by our core invoice financing product. Demand for our product is strong, and we have the processes, funding, technology and people in place to capitalize on this opportunity. Thank you, and we're happy to take questions.

Thanks, James. So I've just got a question that's come through, and I'll go through this, read it out. The commentary at the AGM seemed a bit more upbeat than what was ultimately reported in the first half results. Did you see some weaknesses in late November and throughout December that impacted the business? And how have you seen the operating environment throughout January and February?

The funds in use that we lost in the first half and the relatively wide margins that we had that on, and that was largely replaced by timing at much tighter margins. So the overall total margins of the book is one thing that has changed. Generally, there is a lot of economic stress in the economy for SMEs. And I think that was [ we're a ] bit cautious with the outlook. There's 2 sides to that coin, that it means that we're seeing large demand for our product, but also, of course, the credit risk comes with that.

And I think it's right to say that January and February have been unusually subdued. So I think, we've got some more conservative sort of outlook in the short to medium term.

Thank you. Next question. A couple of brokers have the FY '24 NPAT estimates in the order of $7 million. Presumably, this is an underlying pro forma number. Do you think it's possible to hit this forecast? Or is it a bit optimistic?

Given the shift in the asset mix, it's probably on the optimistic side.

Thank you. Next one. The operating cash flow was quite weak relative to earnings. What was the driver of this?

I think the same as the performance drivers in terms of substitution of slightly tighter lower Funds in Use and tighter margins into the back end of the period.

Thanks, Paul. Another question. How did the breach occur? Was it hidden and uncovered or did it occur post the new warehouse commencing?

Yes. So it was not that they breached full parameter access. So it's in our Equipment Finance existing trust. So it's not related to the new warehouse at all. This parameter was breached or exceeded, detected late last year and a waiver was sorted that time, and we've been managing to a tight parameter since then. Unfortunately, that's unfortunate in terms of timing of the half year. We've had an access on that thing but we're going back to the senior mezzanine noteholders to negotiate a change in that parameter.

Okay. Just holding on for a couple more seconds. Nothing else has come through in terms of questions. Have you got any final statements, James and Paul.

No. Thanks, everyone, for joining.

Yes. Appreciate it.

Thanks, everyone. This concludes today's webinar.