Good day, ladies and gentlemen, and welcome to the Upstart Q2 FY 2021 Earnings Call. Today's conference is being recorded. At this time, for opening remarks, I'd like to turn the conference over to Jason Schmidt. Please go ahead, sir.

Good afternoon, and thank you for joining us on today's conference call to discuss Upstart's second quarter 2021 financial results. With us on today's call are Dave Girouard, Upstart's Chief Executive Officer; and Sanjay Datta, our Chief Financial Officer. Before we begin, I wanted to remind you that shortly after the market closed today, Upstart issued a press release announcing its second quarter 2021 financial results and published an Investor Relations presentation. Both are available on our Investor Relations website ir.Upstart.com. During the call, we will make forward-looking statements, such as guidance for the third quarter and full year 2021 related to our business. These statements are based on our current expectations and information available as of today and are subject to a variety of risks, uncertainties and assumptions. Actual results may differ materially as a result of various risk factors that have been described in our filings with the SEC. As a result, we caution you against placing undue reliance on these forward-looking statements. We assume no obligation to update any forward-looking statements as a result of new information or future events, except as required by law. In addition, during today's call, unless otherwise provided, references to our results are provided as non-GAAP financial measures and are reconciled to our GAAP results, which can be found in the earnings release and supplemental tables. [Operator Instructions] Later this quarter, Upstart will be participating in the Deutsche Bank Technology Conference on September 9, the JMP AI Fintech Conference on September 10 and the Piper Sandler Global Technology Conference on September 13. Now I'd like to turn it over to Dave Girouard, CEO of Upstart.

Good afternoon, everyone. Thank you for joining us on our quarterly earnings call covering our second quarter 2021 results. I'm Dave Gerard, Co-Founder and CEO of Upstart. First, let me once again thank the entire Upstart team for yet another exceptional quarter. The results we announced today don't just happen, they are the product of extraordinary effort by an incredible team. Despite the ongoing challenges the pandemic has brought to you and your families, you continue to deliver. The last 1.5 years have been a challenge for my family as well, and I'm grateful to be on this journey with each of you. Upstart is a leading AI lending platform, and our second quarter results continue to demonstrate why this category can generate enormous value in our economy. They also demonstrate why Upstart has an opportunity to become one of the world's largest and most impactful fintechs in the years to come. Lending is the center beam of revenue and profits in financial services and artificial intelligence may be the most transformational change to come to this industry in its 5,000-year history. It's our view that AI-led disruption targeting dramatic inefficiency in one of the largest segments of our economy is worthy of your attention. Our Q2 revenues grew to $194 million, up 60% compared to the prior quarter. June was our first month with more than 100,000 loans and more than $1 billion in origination volume on our platform. And we achieved this growth while also delivering record profits with adjusted EBITDA of $59.5 million and GAAP net income of $37.3 million. We're also happy to report that more than 97% of our revenue came in the form of fees from banks or loan servicing with 0 credit exposure or demands on our balance sheet. In the second quarter,…

Thank you, Dave, and thanks to everyone for joining us today. We'll dive straight into our most recently quarterly results. Revenues in Q2 came in at $194 million, up 60% quarter-over-quarter from Q1 of this year. As a side note, we will omit references to year-over-year growth rates for our P&L this quarter as they are all well above 1,000% due to the lapping of last year's pandemic impact. Of that total revenue, $187 million or 97% of the total came in the form of revenue from fees. The volume of transactions across our platform this quarter was approximately 287,000 loans, up 69% quarter-over-quarter, partially driven by a 240 basis point quarter-over-quarter increase in the conversion rate up to 24.4%. The balance of our growth in transaction volume came from an increase in the number of rate requests we received this quarter as our marketing programs scaled in response to the conversion funnel improvements of prior quarters. Our contribution profit, a non-GAAP metric, which we define as revenue from fees, minus variable costs for borrower acquisition, verification and servicing was $96.7 million in Q2, up 73% quarter-over-quarter and representing a 52% contribution margin, up from a margin of 48% in the prior quarter and 32% 1 year ago. This level of contribution margin remains quite elevated, partially due to the ongoing improvements to our conversion funnel and in part owing to some onetime gains realized in the fair value of our servicing rights due to the updating of certain underlying assumptions. As we have discussed on past earning calls, we continue to expect this level of contribution margin to moderate downwards over the coming quarters as we accelerate investments in marketing and operations. Q2 operating expenses were $158 million, up 49% quarter-over-quarter or 40% quarter-over-quarter when netting out the impact…

[Operator Instructions] We'll take our first question from Ramsey El-Assal with Barclays.

Another super strong quarter here. I wanted to ask about the components of guidance. If you can kind of help parse this out -- parse out for us rather, what is macro or loan market rebounding more broadly improvement in the conversion rate you might be anticipating, which -- or versus maybe auto contributing? I'm just trying to get an idea from where the drivers are for the full year guidance increase?

Yes, sure. Randy, this is Sanjay. Thanks for your questions. So I think in keeping with tradition over the past few quarters, our assumptions around the macro environment are static. Meaning, we're not really predicting either a deterioration or a rebound in the economy with respect to our numbers, we're sort of predicting the status-quo, which I guess importantly for us, means credit card balances remain quite low and savings rates remain quite high in the economy. So we're not necessarily predicting a change in either of those statuses. And with respect to auto, we continue to have no meaningful contribution to the economics in fiscal year 2021. So really, everything you're seeing in our guidance is our evolving view of our core personal loan business, how we're seeing the funnel evolving? And obviously, as the second order effect, how our marketing programs are catching up to the efficiency of the funnel.

Okay. I wanted to ask about conversion rates. That seems to have been a pretty significant driver of the beat this quarter as well as in the past quarters. Could you talk about the pipeline of improvements that you have maybe and the wings there? What should we expect in the third quarter? And sort of what is baked into guidance in terms of that conversion rate?

Randy, this is Dave. Like always, we kind of have a significant backlog of projects that we're working through that potentially improve the funnel conversion. I mean it's kind of the core way we grow is improvements to our models or some of the technology that helps borrowers get through our funnel. And we continue to have a significant number of model upgrades that we expect and such. We don't always know exactly the -- exactly what the impact will be, the scale of it. So I think that's unbalanced reflected in the guidance, which is a continued pipeline, some smaller things, some that have potential to be larger impact. Some are related to approvals and rates offered to consumers, others are off related to friction and reducing friction. So it's a little bit of a mass and we don't have anything particular to point to other than to say the team is working really hard to get upgrades and improvements into the model that are going to make the consumer product better and it's going to make Upstart's business more successful.

And what about what might be baked into guidance?

Yes. And maybe as part of that, I can just address the initial assumption, Ramsey, which is we did have good continuing progress in terms of our conversion rates on our funnel, we're sort of pushing up against 25% this quarter. But a lot of the growth actually did also come from scaling up our marketing programs to scale up to the past few quarters of gains that we've had. And if you look at the breakdown of those, we see that actually a majority of the growth this quarter sequentially came from the top of the funnel in fact. And so that sort of plays into how we think about things going forward. There was additional gains this quarter on the funnel. And so the conversion rates and in fact, the contribution margins actually went up even though we scaled our marketing campaigns like more than 50% quarter-over-quarter. But a lot of what we're thinking about next quarter and in the back half of the year also has to do with scaling up the marketing programs to continue to catch up for that funnel efficiency. And our historical sort of breakdown between top of funnel and then conversion rate efficiency tends to be about 50-50. And I think that's a rough ballpark for how we're thinking about the back half of the year. Without getting into specific projects, I think that's the rough breakdown in terms of how we see the rest of the growth happening this year.

We'll take our next question from Ron Josey with JMP Securities.

The super strong quarter. Dave, you mentioned in your opening remarks, the goal of launching multiple new products for years to come. So maybe this is a little bit of a bigger picture question. But just talk about Upstart's core AI approach, the data corporates that you have as you think about these newer opportunities and verticals that go through? So obviously, we're in personal lines, we're in autos as well. So maybe talk to us a little bit about verticals, remind us there and/or potentially expanding the borrower profile, which I think you mentioned targeting customers previously ignored maybe going further down funnel, if you will? And I have a follow-up.

Yes, sure. There's just a lot of opportunities that we have always considered, what we're building is kind of a core technology and have chosen the first place to deploy it, which is unsecured personal loans of a certain nature. Meaning, loans that are $1,000 to $50,000, that's the range on our platform today, serving a bunch of kind of use cases for consumers. But there's obviously a much bigger world out there. Auto and our efforts in Auto were really the first time to expand this technology into a secured loan, which behaves differently and has very different attributes to it, has a bunch of different problems to solve, but benefits enormously from all the history in the personal lending world, which is very focused on underwriting individual. So I would just say, look, we look for inefficiencies in the market that are very large, where the opportunity to improve the life or the access to capital or credit for the consumer is vast. And we think there's a lot more in the unsecured lending space for sure. Personal loans are a very, very useful tool in so many ways. And so we expect to do a lot more just within personal lending to solve more problems with that tool. Auto being the secured loan, we're just getting into refinance now. And as you've heard, we'll be into the purchase side of auto hopefully by the end of the year. We'll start to have loans flowing through that. And we just see a lot of opportunity out there. We don't think credit is a solved problem almost anywhere in terms of people getting rates that make sense for them based on their true risk. So you will definitely see us move beyond personal loans and auto, but frankly, we have so much uncharted territory even in those 2 categories that we're not in a particular rush to do so. We are excited to move beyond those 2 categories, I think, in the months and years to come, you'll see us go beyond them. But there's so much to be done, right, in these 2 categories, and that's -- most of our near-term effort is right there.

Got it. That's super helpful. And just a quick follow-up on, Sanjay, to your last answer. I think you talked about marketing and gains in the funnel this quarter. So can you just talk a little more -- or please talk a little bit more, just the expansion of the marketing channels, we've relied quite a bit on Credit Karma in the past. And so I would love to hear how that's evolving.

Sure. I mean I guess I'll say that we did a significant expansion once again of our marketing programs. We grew our marketing spend for -- from about, I think, $45 million, $46 million last quarter to $71 million plus. So we grew our programs by more than 50%, and yet they got more efficient, right? So our contribution margins actually went up, which is rare. It's just kind of underlying that is just the continued strength of the funnel. And then in terms of channels, we are definitely seeing a lot of our strongest growth in channels that are more sort of direct to the consumer and to the borrower. So concentrations in marketing channel distribution are definitely declining across the board.

We'll take our next question from John Hecht with Jefferies.

I guess maybe moving a little bit just to the other side of the network, is talk about maybe some of the investors. Obviously, the performance of the asset is very strong. But any changes in terms of kind of composition of investors or geographical presence or how the investors are tying into the platform over the past 2 or 3 months?

John, you're referring to the loan investors?

Correct. Yes.

Sure. Yes. I mean I think the only thing to call out really is just an ongoing expansion of the overall universe of investors. We tend to get -- we continue to get a lot of new folks who are working with us as the product matures as the history is in the curve is mature, and that's been an ongoing sort of evolution for a couple of quarters now. With respect to geography, I mean, we've got some engagement with international investors now, which is let's say, more recent. And of course, the credit markets themselves as a macro statement are pretty constructive right now. But yes, overall, I would just characterize it as a continuing evolution of a program that's working really well and expanding.

Okay. That's helpful. And then I think Dave mentioned that there's a couple of banks that kind of in a sense, dropped the FICO requirement because there's -- they have a greater faith in the score. I know it sounds maybe that's recent, but that seems like a pretty positive development. And have you seen a market change in terms of maybe adoption or volumes coming out of those institutions? And do you think there are more to come?

Yes. I think I would see it as a trend that we would have hoped for, which is FICO -- a FICO minimum. Meaning, a bank saying, we only lend above 660 FICO or 680 FICO, what have you, is from our perspective, a bit of a guardrail. The model itself, of course, should convey risk and help you make the right decision and FICO as a bit of an artifact of history in terms of it being a hard cutoff. So -- but of course, we're not here to tell banks what their credit model should look like. So we gladly put the constraints on that, makes sense for their risk committees. But we're just happy to see as these banks see performance over time -- In this particular case, and we're hopeful this will be a trend, as they start to trust the model. The model actually -- it does include FICO. FICO is part of the model. It's just not a hard constraint on who can get a loan and who can't. And I think that trend to us is -- in retrospect, it's fairly obvious this should happen, but I think it's really taken some time and probably will take some time to flush through because there's so much history with FICO that naturally banks have relied on it and feel comfortable with it. So -- but it's a good thing. It means they can lend to people they couldn't lent to before. The performance is as good or better than it was. It doesn't have any impact there. So generally, we view it as a good thing for consumers and good things for forward-looking banks.

We'll take our next question from Pete Christiansen with Citi.

Gentlemen, thanks for the questions, and you iterated pretty impressive results there. I wanted to dig into the average loan size a little bit. I know that you called out there was an AI change, which removed the minimum amount? And I guess you could also make the argument that government disbursements have increased savings and sure those are contributors. But I was just curious if there's been any use case changes or any noticeable changes between debt consolidation and perhaps other uses, I don't know, vacation home improvement, et cetera? I'm just curious, if you've seen any underlying developments there? And then I have a follow-up.

Thanks for the question. This is Sanjay. I don't think any very stark changes in use case. I think there's a combination of things that are internal to our models. The example that Dave mentioned is 1 example of something that will -- at the margin change in the mix to lower sized loans, there were other changes to our model that increasingly will compete to an expanded universe over time. And what that means is, we're expanding downwards on the prime spectrum in terms of our capabilities. And of course, that will have an effect on loan size mix as well. And then we think that there's probably some macro effects continuing in the economy, and those are a little bit harder to measure. But we have seen since certainly the onset of COVID, a pretty clear trend that I think is moderating, but it's still sort of visible, which is that loan sizes and demand for loans in terms of what's being requested has moderated downwards in the last 18 months.

That's helpful. And then looking at your -- on the supply side, again, you've obviously expanded your network with investors. And I know that in recent past, there hasn't been enough demand to satisfy your investor demand, I guess, for loans. Just wondering if you could talk about the supply/demand balance now, whether or not third-party investors are getting enough supply and if there's any other constraints there?

Sure. Yes. I mean we've had definitely robust increases on the supply side, both with our number of banking partnerships, which has increased nicely as well as the investment dollars that flow through the institutional world. But I think we're in very much the same position of equilibrium that we've been in the past, which is -- there's -- finding the borrowers economically and profitably tends to be the limiting factor in our growth, and I think that's probably still the case even at this new level of volume.

We'll take our next question from Nat Schindler with Bank of America.

Yes. And just before the question, I want to do a quick quibble with some of my colleagues here on the sell side. Pretty impressive results and another strong quarter seen a bit understated when you're talking about quadruple digit growth, which might be a first in my career. What's more impressive is as you mentioned early on, this was on the back of an -- even if you take that out, that Q2 of last year was -- you turned off revenue. So -- but if you compare it to Q2 of '19, you're still looking at fivefold growth on that year. And if you look at the TransUnion data and other data on the personal loan market, obviously, the personal loan market is still down as credit card balances have fallen. I know you mentioned that in your forward guidance, you're not predicting any change to what has happened. But as we think about -- what do you think your growth would have been on a more normal -- maybe in the first half of this year in a more normalized market for personal loans, where credit card balances are higher and they're on stimulus packages pushing down the need for personal ones?

Matt, this is Dave. It's, of course, very difficult to speculate. But for sure, I think what we would say has happened is a shift in leadership and a shift in market share driven by a significant disruption to the market, i.e., the pandemic. And so a difficult time in the market, whether that's a recession or some other kind of event really begins to show the differences between strength in platform. And I think that's really what happened. That really explains the very, very large growth in market share and et cetera that happened during this time. So it's a little hard to exactly say what would have happened if there wasn't this disruption. I think we are on a good trajectory. But I do think the nature of the pandemic and the stresses it put on banks and lenders and consumers for time, et cetera, just the uncertainty of it all sort of leaned into our strengths and gave us a benefit that we might have just taken much longer to get to the position we got ourselves to. So that's how I interpret it. It's really, of course, almost impossible to guess what would have happened if things have been different last year.

Yes. But I'm guessing that none of -- I'm not aware of any of your other competitors in the fintech world, which I would imagine have the same sort of strength in being fully a online businesses and the like that the the pandemic helped. I don't think they're growing at 5x over Q2 2019. I haven't heard of anyone in the space growing at that kind of rate. Obviously, you're taking share that sets something to the better mouse trap. But how should we start thinking about how this starts normalizing out as we move to a normal market where the personal loan market is actually growing instead of shrinking as it is right now?

Yes. I'll just say it's a little difficult. I mean, we certainly feel this is happening with a bit of a headwind meaning the demand side for credit is still down, as Sanjay referenced earlier. And when that will change? We don't know. We don't bank on it. We don't include anything -- any sort of assumptions about that in our guidance. But there's -- we benefited also because our credit was resilient and responsive and our bank partners saw that, investors saw that. And that allowed us to come back quicker. When the economy is considered normalized by everybody, whatever that means, maybe unemployment gets all the way back to pre-COVID levels, I think you're going to see a lot more activity in the market by everybody, by other banks who don't work with us, by fintech competitors. So I would just say, I think there's a chance and that we're hopeful there will be a boost in demand by people spending more spending -- tapping credit again as they might have pre-pandemic. But there's also more, I think, competition out there who's now back in the game and fully focused on themselves growing. So how that nets out a little hard for us to judge, but those are the dynamics that we would expect to see in the coming quarters.

Thanks for your question, Nat. I think we have time for 1 more question.

Our final question is from Mike Ng with Goldman Sachs.

This is Adam Hotchkiss on for Mike. I believe you mentioned auto loans to date. But could you give us a sense for how many of those were during the quarter and how the margin profile of that product compares to the traditional personal loan product. And then on Prodigy, you mentioned you've doubled dealers since the beginning of the year, which seems like a pretty rapid pace of growth there. Could you talk a little bit just about the enterprise sales strategy that's driving that and the sort of the pacing for Prodigy in the back half of the year relative to the first half?

This is Sanjay. Welcome. Welcome back to the party. I'll take the first question and defer to Dave on the second. But with respect to auto, look, Dave threw out a couple of numbers in terms of our ramp. It's still very early days. Obviously, we're starting to see results and build repayment history. we're starting to sort of improve the funnel sequentially month-over-month. So we're in a good path there, I think. And with respect to margins, I think it's still very early. We're still in the early stages of engaging with banks and engaging with investors and understanding the effects of fees on the conversion funnel and things like that. But I think our expectation remains that the loans are clearly bigger and so there will be a higher dollar revenue per loan. And we're expecting probably a similar dollar contribution profit per loan as we see in personal loans. So the percentages will be a little bit different because the loan size is bigger, but that's our current going assumption.

Yes. And Adam, the second question you asked about sort of the go-to-market for the privacy software and how that looks. Yes. As we said -- as I said earlier, we -- We've doubled the number of rooftops since the beginning of the year. The acquisition happened earlier this year. And Prodigy in our view is a very good product and a very small team. So it is a huge area of investment for us. In fact, I think we've said a couple of times, this is an area where we're going to overspend to build our go-to-market. And that team is largely what you would think of as inside sales team very focused on fast volume sales. And we are -- we care most -- I mean there is actually some bits of revenue that come from the use of that product, that's not really the long-term plan for monetization. It's, of course, through the offers of credit through it. But today, we're focused on ramping that team very quickly, both really in the sales and marketing function. And as well, by the way, on the R&D side, because Prodigy is just -- has a great leadership position, is growing very quickly and has done that with very, very modest sized teams. And we definitely believe it makes a lot of sense for us to invest more in that. So that's happening right now. And we're tracking very aggressive goals for a number of rooftops that are signed up every quarter, and that's something we're watching very carefully.

This does conclude today's question-and-answer session. I would like to turn the conference back to your speakers for any additional or closing remarks.

This is Dave. Just going to wrap up here. And I just want to reiterate, we're obviously pleased with the results. I think they do illustrate the type of company we are building. We think we have an opportunity to build one of the top handful of fintechs in the world because we are in a very, very large space and because we think AI really is the future, it's the most transformational change that's happened in that space. So that's why we're excited. So thanks to all the Upstart team for delivering the results, and thanks for everybody out there for being with us. We look forward to seeing some of you over the next quarter. Thank you.

Ladies and gentlemen, this concludes today's conference. We appreciate your participation. You may now disconnect.