Affirm Holdings, Inc. (AFRM) Earnings Call Transcript & Summary

Great. Welcome back, everyone. Today, we're super pleased to have Michael Linford, CFO of Affirm with us. Michael, thanks so much for being here. Appreciate your time.

Thank you for having me.

Maybe we'll start with a question on the recent quarter. The fiscal third quarter results came in well ahead of expectations and your guidance. What were the drivers of the outperformance, sort of broadly speaking? Where in your business are you guys kind of exceeding your internal expectations?

Yes. We had a great third quarter, both tactically in that we posted some good numbers and a solid print from our perspective, but also made a lot of progress on the strategic goals. I think the best way to frame the conversation is around what growth looked like with Peloton and without. So excluding Peloton or growth rate from a GMV standpoint was 100%. And that's a real acceleration from the growth rate that we saw in prior quarter, which was about 55%. And so you're seeing us start to normalize out of this whipsaw that we went through over the past year associated with actions that we took and frankly, the economy took in response to COVID. And we saw growth across all categories and really strong growth across all categories. In fact, we were ahead of expectations everywhere in our business. And we believe the biggest driver of these results is the economic recovery. So as the economy opens back up, we're actually beneficiaries of this. One of the things that we talked a lot about during the fall and winter as we went through our IPO was how we were uniquely positioned to take benefit of the massive pivot towards e-commerce, and we did. You saw that in our numbers. The thing that we didn't spend as much time talking about, and probably should have, is that we're actually beneficiaries of the reopen as well. And that has a lot to do with the categories that -- the category Tread that Affirm plays in. So while we obviously are big in categories that benefited during the pandemic, like home and effective fitness and the kind of categories that you'd expect people to buy in times when the economy is more restricted, we also have big businesses that were suppressed during the crisis, like travel. Travel is one of our favorite categories to talk about just because it's a light-switch moment where you're going from highly depressed volumes to, as things open up, it's something that consumers are going very quickly with their dollars to go out and see the world. So we saw a real acceleration in travel. We're excited because this time last year, things were shutting down rapidly fast. And so we think that we're up against a pretty easy -- a relatively easy comp, which allow us to deliver real strong growth. But it's also a great way for us to help consumers as they get back into the economy in normal modes. And highlights, we think, one of the best and most important differentiators of Affirm is that we're able to play across all parts of the economy. And we're not limited to fashion or low AoV or high-velocity purchases. We're able to meet consumers where they are with what they're buying across all the different categories.

That's terrific. I wanted to then ask about another thing that's pretty top of mind for folks, and I'm sure for you guys as well, and that's the Shopify rollout. It sounds like it's obviously really picking up steam at this point. Can you give us a little color on the kind of the mechanics of the rollout? Is this just you enabling merchants that already take Shop Pay? Is there an opt-in process? How does it work?

Yes. So we're really excited. It's interesting, in between the time when we wrote the script and the press release for our last earnings call, and then on Monday when we did the call, we already had 2,000 merchants. So one of the things that we talked about with everybody last earnings call, if you remember, we reported that we got to 100 merchants and people were scratching their heads a little bit like, doesn't actually make sense with the size of Shopify. And the thing we stress to people is it's not like a linear rollout. We're not going to add 100 every month. It's -- and we're in the middle of that inflection right now where you see us going from truly testing the plumbing to now we're turning on the faucet, and we're literally opening the spigot as we speak. In terms of the mechanics, it's couple of things. The first thing is with respect to go-forward new merchants for Shopify, when we get to our [ GA day ], which we announced it will be in June, we will be able to have Shop Pay Installments on by default. And why that's exciting is because at that point in time, kind of the future merchant growth of Shopify and Shop Pay is partnered with us. And merchants, of course, will have control over what payment methods they accept but by default it's going to be on. And given the conversion impact we think it delivers, we're pretty excited about merchants leaving it on. And with respect to the existing Shopify base, which is obviously larger because they're growing fast, but not 100% a year, we are doing outbound marketing. So merchants have received e-mails, for example, notifying them that the Shop Pay Installment product is available. And on their merchant dashboard, the payment methods, dashboard, they're able to opt into Shop Pay Installments and review the terms and the pricing there. And they'll be able to do that with one click. This is the most exciting thing. Whether it's a new merchant and it's on by default or an existing merchant and you want to go flip on Shop Pay Installments, it's quite easy enough that I could do it. I go in there and yes just click, "Yes, I want Shop Pay Installments," on the site. And so in terms of what we're trying to do right now, the real focus is around lighting up as many merchants as we can on the Shop platform, address lots of merchants. And then once we get the product well distributed, we'll begin rolling out more features and benefits to improve adoption and take-up on the consumer side. But we're at that really cool moment where we are in the midst of a very wide and very rapid rollout of the product.

Okay. And how does -- I know you have a small sample size at this point, but how does the average merchant using shop installments kind of compare to your broader installed base? I mean, I'm sure it's a higher percentage of SMBs, et cetera, but maybe you could just speak to that for a second.

Yes. Affirm has really built its existing merchant base as of, I'll call it, last year on larger merchants. One of the anecdotes that we shared here, just to give a perspective of just how much larger enterprise Affirm has built to serve. We talk about our enterprise merchants and Shopify has enterprise merchants on their platform. And their definition is more SMB for us, right? So an enterprise merchant on Shopify fits more of our SMB base. And the reason why that's an important understanding is that you have to put context for who the Shopify merchants are. They have very large merchants on their site. Truly tens of the hundreds of millions of dollars volume on a merchant. But the tail there is really, really long. And one of the things that we were able to do as a leadership team is actually quite fun. We had to do a bunch of screening for the Shopify merchants. And so most of the leadership team actually dug in and contributed some effort to screen these merchants. And we're just trying to comply with our prohibited business policy. And it was a great experience because it just shows you the slice of American really international entrepreneurship that Shopify enables. And it is a very, very long tail. Now there's plenty of great marquee merchants on the Shopify's platform. But some of the magic happens when it's a small store with maybe 10 or 15 items. And these merchants aren't driving huge volumes, but they're able to put up a shop very easily. It's the power of Shopify's platform. So in general, these merchants are going to be smaller. The volume for merchant is going to be a lot lower. In fact, a lot of these merchants were merchants we couldn't serve but for this partnership, just given their scale and the underwriting. That's so difficult for us to do on the tail -- on the merchant side. So it's a smaller merchant base. It's a merchant base that's generally less focused on optimization, right? So when we get into a conversation with some of our enterprise merchants, we're talking to a payments team. The vast majority of Shopify merchants don't have a payments team. The entire company is a handful of individuals. And so it's a very different merchant mix. And yet, there's a lot of commerce being conducted across that very wide merchant base. And our goal here was to build a product that merchants could adopt easily. They could onboard quickly without a payments team, and they could actually get real results out of because despite the relatively lack of scale per merchant, there's a lot of merchants and that math happens due to the breadth of the merchant base and this is there in the tail.

Okay. And this relationship really helps you guys kind of move into a lower AoV transaction, obviously. I mean what are you thinking -- just kind of an industry question, not necessarily sort of on Affirm-specific question, but how penetrated to sort of everyday spend might we see this kind of financing? You have other geographies like in Brazil, for example, where there's financing of very low tickets and everyday spend. Is that something that you can see -- you'll see this industry and potentially Affirm as a participant in this industry sort of evolve towards? Or where do you think the lower limit is?

Yes, yes. So if you think about how we think about the world, frame up the trend that's going on, we think that what's happening, and there's plenty of models you can -- like you mentioned, you can look internationally. But you see in the U.S. data, too, consumers are very rapidly changing their preferences here. And we believe it's driven by a desire to have a more transparent and, frankly, less cumbersome and complex financial product like a revolving credit card. And they're voting with their dollars very, very fast. So you have this major trend, which is consumers are voting very quickly to say, we want to get out of the traditional way of paying for things, and we want to adopt these new ways that bring more transparency to the ecosystem. And with that, we think it's not limited to a particular AoV type. We talked a lot about high AoV and low AoV. High AoV is where we kind of grew up, and we have a very defensible position in because it's very difficult for these pay-in-4 providers to do more than paying pay-in-4. They have 1 SKU with no customization, and it's just pay-in-4, and that's it. And the things they tweak around the edges are pretty minor, whereas Affirm is able to offer a wide range of order value. So we can go up to thousands of dollars in purchases, we can go up to 48 months in payments. And why that's important is because you take $1,000 purchase and break it up into 4, still $250 outlay, it's a lot. If you take $1,000 purchase and you spread it over 48, the multi payments become something the consumer can actually digest. So there's -- and technology is a real key piece of that particular piece of the space. So we think on the high AoV, we think we have a pretty defensible and really strong position, market-leading position. In low AoV, the current definition of low AoV is kind of like that $50 to $100 range and $150 range. And that is very much being the higher competition. We've got a lot of folks in that space right now, and we've made our bets finding strategic partnerships like Shopify and focusing on a key sort of enterprise accounts that we think we can provide some differentiation in a space that's quickly becoming quite commoditized. But we don't think the limit is the $50. Part of the reason we announced the Affirm Card earlier this year is we do believe that we'll be able to address transactions all without the daily spend. And we think that the winner in this space is going to be -- you can address the biggest part of the transaction types. So high AoV, we think we have a strong position, and we're going to keep that leadership and keep investing there. Low AoV, we have our bets made and we have, frankly, a lot of investment behind winning the portions of that space that we think we should win. And super low AoV or everyday spend, we think is on the horizon. And we think that the reason we're best positioned to win is we're a lot more than pay-4. We can do the whole range. Consumers are spending it. We can underwrite it and bring that transparency that consumers are asking for. And again, we think it's an inevitability that those transparent products win. The question is who's going to win amongst us, and we think those who have the broadest offering to the consumers are going to be the winners.

That makes a lot of sense. Well, a good segue to talk about the debit card. It's an interesting product. Maybe you can update us on the thoughts around launch timing, but also kind of just walk through the value proposition. That sort of Buy Now, Pay Later is so interesting because it sort of occupies this space in the consumer mind between credit and debit and it seems like this card threads that needle nicely. So maybe elaborate on that a little bit.

Yes. So we're not giving any updates on the rollout time. The team is very much hard at work at landing it. And it's important to think about this product the same way you would for any of our products, which is we're going to launch something that kind of meets the bare minimums, we call MVP, get out there with the product and let consumers begin working on it. But the vision for the product long term is really, really broad. And so we talked a lot about Affirm as a two-sided network. And on the consumer side, we launched the savings product last year, and that was really intended to begin to give consumers a way to store value, which is a different part of their financial lives, but an important part and interestingly related to how they spend and spend on our platform. Of course, we have our core installment loan products and our low AoV products. And we think this fits nicely on the consumer side as another way for them to trust Affirm in more transactions. On the merchant side, the product, as we're contemplating it right now, is not going to launch with a bunch of merchant features. But it is something that we want to get added to the mix as we think about the long-term vision here.

Great. I also wanted to ask about Peloton. You gave us some really helpful color on the impact of equipment returns with Peloton and also Peloton lapping last year's COVID-related acceleration. How should we think about the kind of cadence of the Peloton contribution as they kind of anniversary some of these things as we get deeper in the year, relaunch Tread, things like that?

Yes. So I think there's obviously a big chunk of our business that was the past 12 months tied to Peloton, although you're seeing that go down. As we talked about earlier, our ex Peloton growth rate continues to accelerate. And so you're going to see Peloton deconcentrate, not because it's not a great product with tons of consumer demand but just because the rest of the growth in the portfolio is beginning to pick up as we lap 2 things. One is the really strong quarters that Peloton had. The second is we were very tight with respect to credit. And one of the things we talk a lot about in terms of how Affirm manages through cycles is that we can make really quick rapid changes to our portfolio overnight. The short nature of our asset means that if we make slight changes to our credit box, for example, we end up in a fundamentally different position. And we did that this time last year in anticipation of record unemployment. It turns out that we didn't need to. Our performance was phenomenal. But nonetheless, we're up against a box that was tighter and a flight towards quality. And Peloton was a key source of that quality and volume in the prior years, combined with the fact that there was obviously the secular shift towards working out at home, this incredible consumer passion for these Peloton products. We think that the Tread recall from a financial standpoint is actually quite de minimis. The $3.5 million number that we saw in the prior quarter, it puts it behind us. We don't anticipate there to be any material further headwinds associated with the Tread recall. Clearly, there'll be less Tread units sold until they get the fixes worked out, but it was never a super material part of the business anyway. But I think to come back to your framing, we did see pretty strong growth in Peloton last year. Part of that was shelter in place that we talked about. The other thing, and you may remember this, but they launched a new product in our fiscal Q1 last year. And so in Q4 and Q1, we're up against really, really heavy Peloton numbers. Now if you normalize those out, going back to the prior year, we think there's still lots of strong growth. So this is a long-term thing that we'll be carrying around with us. We think this is -- we're up against gaudy numbers. We think it will normalize out. And against '19, in absolute sense, there's a tremendous amount of growth. And we're not seeing the consumer demand slow down. We're actually seeing this is one of the best examples of categories where consumers have changed their behavior permanently, not temporarily. They prefer finding out ways to work out at home. There's a lot of benefits to that, that are beyond just the safety and lack of disease transmission inside of a gym. We recently did a survey and found that 70% of consumers are going to keep working out from home even after the pandemic fully opens -- fully resolves itself and everything fully opens. They've been hooked on it. It's a fantastic way to get a good workout. You'd still not expose yourself in any way. So in summary, we're up against some really big numbers. We're not giving any specific guidance, but one of the things to think about is we're not assuming a ton of year-on-year growth from Peloton the next couple of quarters as we comp some really big numbers. And our guidance fully reflects that. So if you back into that, it implies further acceleration in our ex Peloton business. And this is we think one of the great things about Affirm. We have such diverse mix of verticals that whenever we're up against some really, really heavy numbers, we've got businesses like our travel business that can help step in and still provide real growth for us because we play across all of the verticals. So we're excited for the growth that we're going to deliver. Peloton's consumer adoption hasn't slowed down, but it's difficult for them to grow on top of things like product launches. And so we do expect this year's growth rate to slow, not because it's a harbinger of like further trend, it's just up against really gaudy numbers and against '19's massive growth.

Okay. I wanted to pivot over to your M&A pipeline and M&A strategy. We saw you recently acquired Returnly. Maybe you can kind of give us a little bit of context in terms of how that fits into the strategy. Obviously, PayBright before and getting into Canada. How are you thinking about M&A here? How should we think about it?

Yes. I mean the first thing to know is that we're really mindful of not getting too far over our SKUs on this. And so for us, we take a very thoughtful approach. It needs to fit strategically in the portfolio. There needs to be some sort of accretion and how we think about our long-term value creation, which for us really comes down to just reinforcing our network. On Returnly, why we're so excited about this is, it's an additional merchant service that we think creates a lot of defensibility, especially in low AoV. We talked earlier about how competitive that space is, and it's really competitive. But Returnly is an additional merchant service in these high-velocity fashion items where the return rates are really high that merchants really value. We talked to our merchants over the past several years. And indeed, part of the reason we invested in Returnly 2.5 years ago was because we saw this as a key pain point in the consumer life cycle, the returns process takes. And from a merchant standpoint, it's a lost sale. And it's a lost sale after you've gotten all of the costs associated with customer acquisition and conversion, including, by the way, Buy Now, Pay Later solution and now you've lost that sale. And the conversation we have with merchants a couple of years ago was, we need to help drive in consumers back to the store. And at the time, we thought it was kind of backwards. We really think the right answer is let's recover the sale with a digital solution like Returnly. And we got to know the team over the years and think this fits really, really well into our portfolio because it's always a real problem for the merchants, and creates a good consumer experience. And the last part, there's enough risk-taking in these transactions, meaning you're extending credit to the consumer so that they can actually complete the transaction. And there's enough risk-taking that it's not something that traditional pay-in-4 guys can just jump into blindly. We think that our risk-taking capabilities are synergistic with theirs. So it creates additional value for the merchant, earns additional merchant fees, drives more G&P growth for us and creates a stickier product that we can bundle in with our Buy Now, Pay Later solution and really help the merchant solve the problem from acquisition, conversion and then even the full life cycle on returns. PayBright, similarly, was focused on enhancing our network on the merchant side. There's a lot of cross-border merchants that we thought were important to protect in the U.S. We didn't think that it was good idea to let those merchants go the way of any of our competitors. And so we wanted to make sure we protected them. Additionally, the same trends going on in the United States are going on in Canada. PayBright contributed about 2.5% of our GMV last quarter, which is certainly not the largest number but it has got a lot of growth in it. And that growth is because the same trends going on in the United States are going on in Canada. And while Canada is only roughly 1/10 the size of the United States, it's still roughly 1/10 the size, and we thought there was a lot of opportunity for us to build a $1 billion business up there. And that's what we're focused on doing, in particular, to serve the merchants in the U.S. who cross those borders, of which there are many. So in both cases, the investments we've made have been around reinforcing our network. As you also know, that both teams bring technology, consumer and product expertise that's really viable to us. And I think that going forward, the focus for us in M&A is going to be similarly what can actually aid in building our network. So it's going to be a strong merchant -- or consumer value prop. There probably has to be something defensible or unique about it from our standpoint, which either involves risk-taking or a really strong technology product that's hard to replicate from our competitors. You probably won't see us go out and try to just do some sort of vertical integration or try to gobble up the competitors in the space. That isn't the intention from an M&A standpoint.

Okay. Well -- and you mentioned a little bit ago, competition in the space. That's something that's top of mind for investors. Talk about the competitive environment. Are you seeing any shifts, any changes? How do you think it evolves relative to your offerings?

Yes. So again, I think we just start by thinking about where the competitors play, okay? And part of the reason we like talking about travel is because there's lots of growth there, but also it's a product that our average order values -- our averages are in excess of the maximum amount that PayPal is paying for, for example, addresses. And we believe risk-taking actually matters in these spaces, the higher average order value you get. And we believe that one of the things that Affirm does demonstrably better than our competition is actually grow the average order value regardless of where it starts. We make a $50 basket bigger than our competitors, just like we do like a $100 basket. So we have, a, we think a defensible position around some of these ideas. But it's definitely clear that the growth in consumer adoption is attracting a lot of competition in the low AoV space, in particular. So we're thinking $50 to $150 ticket sizes, mostly in categories like apparel and fashion and beauty. These categories have a lot of competitors in the space right now, and there's obviously a lot of noise being made about it. What's important from an investor standpoint, we think, is because there's a lot of conversation around our take-rate. And we really think investors and analysts alike, present company excluded, are misunderstanding how to read our merchant revenue line. Our third quarter our network revenue take-rate kind of, excluding Peloton, were flat year-on-year and the same was true in the second quarter. And if we went back 8, 9 quarters, and the number does move around a lot. And everyone wants to assume that the quarter-on-quarter sequential change is a result of competition. And we think that doesn't -- that belies a couple of the mechanics. Firstly, the mix impact in our business is much greater. Our competitor's less so. They have 1 SKU. So if revenue as a percentage of GMV goes down, that means that that 1 SKU is actually getting less revenue yield. But with Affirm, we don't have 1 SKU. We have like an infinite number of SKUs. Let me explain what I mean by that. In the -- we have a pay-in-4 product where you charge an MDR and that's the entire business model. Notably, we don't have late fees like our competition does, okay? But we also have long-term 0% loans that earn much higher MDRs, and then we have long-term and short-term interest-bearing loans. And when I say infinite, I mean that, we can do 0, 3, 6, 12 months. We can do partially subsidized, fully subsidized, interest-bearing or not. And we never make decisions with the merchant based upon the merchant fee content. We make a decision with the merchant on what is the total amount of contribution profit that we can generate in this relationship. And that takes into account all revenue kinds, to merchant fees, interest income as well as all costs, and we call our transaction costs where we report out. And if you look at that revenue less transaction cost trend, even when you normalize it for credit, which you should do because the past couple of quarters has just been phenomenal with respect to credit and we think that a more normalized level is the right way to look at this business, even when you normalize it, the growth rate in that number is really impressive. If you want to understand whether or not Affirm has pricing power, that's the number to look at, where things will get hard. Again, picking on some of our competitors who have 1 product. Any MDR compression results in EBITDA compression for them, right, because they have no other way to generate any economic yield we do. And so looking at the merchant fee revenue line, and this is the point, and even when you do excluding Peloton, we're actually essentially flat for the past couple of quarters. And so we think consumers are reading -- sorry, investors are reading into that line, we think, quite wrongly. And the thing we can say netting all that out is it also misses the mechanics. We're not out every day renegotiating the price with merchants. The vast majority of our merchants have relatively static MDRs. And things that fluctuate are things like promotional programs. So we might, for example, work with a merchant partner to introduce a 0% financing test and that may run for 3 months, and then they go away or become permanent. One of my favorite examples of that is our merchant partner Room & Board, who we love because they treat their consumers really well, going into the crisis they ask us what can we do to help our consumers. We know our consumers need help right now. And so we encourage them to go from an interest-bearing program to at least test a 0% program. And much to our joy and to the consumer's joy, it stuck. And so that program has been made permanent. But if you see, we make the same economic content, whether we were charging Room & Board or the consumer via interest in that relationship. We didn't make more money or less. And we didn't think about it as, hey, we have a chance to go make more money. We thought about it as, let's drive better results for the merchant and let's try to price it in a way where we can accurately estimate the risk and generate the economic return that we're supposed to. And so we don't -- we see that as a bigger driver than any sort of short-term changes. And with all that being said, in the low AoV space, in particular, which for us is still a really small part of the business, it's really competitive. And there are merchant deals being priced right now, new merchant deals that are being priced in really, really aggressive ways. And we do see that as a potential future price compression in the low AoV space if we were to go out and have those fights on a one-on-one basis. The important thing to know about Affirm is that we're not -- that's not our strategy. Our strategy isn't to go win all of those merchants. Now there's a handful we're going to go in. But our strategy, for example with Shopify, was to find a place, a zone that's walled off, that serves the long tail and is able to actually have some level of defensibility. Our strategy with investing in Returnly is to create in low AoV space some way to support higher merchant fees. And these are all things we think a lot about because we do believe that if you're just offering pay-in-4, it's pretty commoditized. And I think PayPal knows that in reverse. They know that their core checkout offering is really valuable. And therefore they can add this feature. I think that our more direct competitors like Afterpay and Klarna are wrestling with the same idea that in that low AoV space, it's really, really aggressive. You need to be doing more than just that solution if you're going to add value to the merchant. And that can come in the form of additional merchant services like we talked. It can also come in the form of consumer acquisition and monetization. We talk a lot about what our app does. 30% of our transactions originate from our owned properties. That is a fundamentally different value proposition for a merchant than just a checkout solution. And all of this is -- really all of these ideas taken together are things that we're doing to defend and support merchant fees in low AoV. And so we acknowledge that we look at this space and that's going on. We think looking at the merchant fee line kind of misses the point, and our business isn't priced or doesn't run that way.

I see. I'm afraid we're about out of time there. There's so much left to talk about, but that was a hugely valuable answer, by the way, the last response you gave. So thanks for that. But I think we have to leave it there, unfortunately. But thanks for your time today, Michael. Always appreciate it.

Thank you so much.