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

Okay. I think we'll get started. I'm Bryan Keane. I cover the fintech sector here, and we've had a bunch of companies, I think, over 25 companies here, and we decided to put the last company, the most boring company that -- as last here. So with that, we're excited to have Michael Linford, the CFO of Affirm to talk to us a little bit about the model. And with that, Michael, thanks for coming.

Thanks for having me.

So let's maybe just start, a little step back for a second and just talk a little bit about the broader BNPL industry, the growth rate, the penetration, where do you see that going?

Yes. I think one of the things I think is lost in the current macroeconomic shuffle is you go talk to a consumer, and they're not keying off of what Chairman Powell said, they're keying off of what they -- how they live their life and consuming things they want. And they're continuing to adopt these alternative ways to pay the industry label that we have on now is BNPL, but really, it's a full set of ways to pay for things over time without using credit cards. And that adoption continues in pretty full force. And estimates are out there and they are nascent. I think we're going to get better estimating as an industry, but we do think that there's somewhere between a tripling and the doubling of the market, driven by the adoption of these alternative ways to pay and continued e-commerce growth. Now I think the current e-commerce slowdown, at least on a year-on-year basis is certainly impacting the near-term growth rate of the category. But the fundamentals underneath it are wide consumer adoption of these new ways to pay. And it's really grounded in the idea that credit cards are not the best way to pay for things over time. And debit cards are a great tool, but they don't give you access to credit. They don't give you purchasing power that you got with a credit card. And so it's really a third way, a very different way to pay.

So these models are new to everybody, I think, over the last 5 years. I mean, you guys have been around for longer, but now we're all paying attention to it and BNPL has become one of the big buzzwords in fintech over the last 5 years. But we don't have a lot of history of thinking about economic downturns potentially that we're going into. What the pluses and minuses -- because there's going to be, I think, obviously pluses and minuses in a downturn in the model, the BNPL model. Maybe you could help us think about some of those?

Yes. I think a couple of things are worth thinking through. I mean, no matter what any of the other players in this space may tell you, there is a credit aspect of this business. We'd like to just be very direct on the fact that we take risk. And when you take risk, you have to manage it through a cycle when consumer capacity to repay is affected by the macroeconomic conditions. And so that will definitely be a factor as we went through the recession, if one does come. And yes, there are some structural advantages that companies like Affirm, and I think Affirm in particular, have in managing through the cycle. The first is that we're really good at underwriting. And I would like to start there because we're very proud of it. And I always like to quickly acknowledge that even if you don't believe that, we still have a real advantage because of the nature of transaction level underwriting of short duration transactions sitting at the point of sale. So we don't have a bunch of money acquiring users. We don't have very long-dated liabilities that we originate. They are very short in duration. And what that does is it gives you an inherent agility. And so the question isn't just can you effectively underwrite is can you underwrite? And use your agility and dexterity to navigate the uncertain times. And I think that's an area where we shine in particular. It's the risk management posture of Affirm as much as it is about the underwriting capabilities, which are really, really good. But that's a -- we talk about sometimes as a treadmill. We sprint just to stay where we're at on credit. You have to keep updating your models, you roll new features. And those are all designed to maintaining an edge over the traditional underwriting methods, and that's great, but that's not enough. The secret sauce is combining that with sitting at the point of sale and looking at millions of applications a quarter and being able to say yes or no to any transaction and being able to do so without being encumbered by decisions you made in the past. The fact that our weighted average life is both short and declining gives us a lot of agility so that we can navigate uncertainty. And therefore, it's just as much about being reactive as it is about being predictive. Underwriting is all about predicting carefully. The business model allows us to be very reactive. And so even if you're not as convicted as we are on the capabilities on the predictive side, how these advantages on the reactive side. And I think they're going to prove out in the cycle where you're going to see traditional kind of flow-through in consumer delinquencies through more traditional credit institutions follow the typical path that you would expect, and you're going to see it be a lot more managed given the agility we have in the company like Affirm.

Got it. Michael, I was hoping, given the broader macro concerns, can you talk a little bit about exactly how you guys see the health of the Affirm consumers in general?

We always start with employment. I think if you think about all the macro indicators, employment is by far the most important. And I think if you wind the clock back to when COVID and the economic shutdown happened in 2020, the reason we took, the risk posture we did at that time was because of the unemployment implications of pandemic. That matters most. If consumers don't have jobs, it's very difficult for them to stay current on their obligations. So we don't have that problem today at all. We have really robust employment and our consumers fully employed and don't see any signs there yet. What we do have is a bit of a different and unique macroeconomic stress going on right now with not the expert, so I feel better even saying this because you guys are all in the room smarter than me, but the rise in inflation puts pressure on the cash flow of lot households, especially in lower credit and lower income segments. And we are seeing that. I think we're not the only ones. I think that's a pretty widely seen thing. I don't think it's right or thoughtful to think about that as like a binary thing or we're nowhere near the kind of levels where cause for alarm, but the stress is there, you can see it. I think some folks have seen it spike more than us. I think some of that is our agility in this place, some of that's our underwriting on display. And some of that is just that some folks have more exposure the segments that were most impacted today. So we're seeing that. But if you step back a little bit, you still have full employment. You still have a healthy consumer. You don't have the kind of weakness that you saw in 2008 happening right now. I think the reason we're cautious right now is because the future is rather uncertain. Think that if anybody thinks they know it will happen in the next year, they're probably kidding themselves. And so our posture and thought is, let's make sure we keep an eye on the consumer, let's make sure we manage the business like a hawk so that we take advantage of the inherent agility in the platform.

The business, obviously, is growing extremely fast, including the whole split pay product in itself. Has that customer demographic changed a little bit for you guys?

So we've always talked about the customer demographic as being very down the middle. It's pretty representative of the U.S. consumer. Before we had Amazon and Shopify's partners, we had Walmart as our largest enterprise partner. And obviously, we still do. And if you cover Walmart and Amazon and the Shopify stores, you're covering 60% of U.S. e-commerce. And so at that point, our consumer is the e-commerce consumer, which is the U.S. consumer. And so no, we're not seeing like a dramatic shift in the kind of consumer demographic makeup of the business. We tend to skew a little bit younger, so we're more millennial and GenZ than we are X and Boomer. But that's a SKU, right? I don't think I don't think it's the right thing to think about it as like all of the consumers we have are there. I think there are other players in the BNPL space, who skew even younger, they skew much more GenZ than we do. And that just more reflects that our business sits where the purchasing power of America sits, especially with those who need to consume credit.

So one of the things that came up on the earnings call was your comment about seeing some of the weakness you talked about in the lower, in the market, but also point to kind of the strength of your business model and the underwriting capabilities, and you've highlighted that as kind of a key thing here. But what's the key secret sauce of Affirm when you say you guys do it better and the data kind of proves that out. But what are you doing differently? Because I think a lot of folks are skeptical that what you're doing is could be that different than anybody else?

Yes. And I think -- the only message I have for the skeptics is keep checking in with us. And I think our track record is pretty great. And yet, it's obvious that a stress in the consumer will flow through any business, and we would expect that to happen to us as well. The question is, is there a stress? Question is, how do you manage it? But first, with respect to our underwriting advantage, I think there's 2 things. One, we have really great machine learning experts, and we take the data that we are able to get and apply it to every transaction, and we're very thoughtful about that. And there's a real advantage there. Our model has performed very well, and those get tested all the time. Separate from the modeling though, is just the DNA and the culture here at Affirm. We've always thought about these BNPL transactions as loans. We call them loans. And that's actually different than some of our competitors in the space, who I think were even borderline boastful about how they don't underwrite. We've taken the view that every transaction needs to be underwritten. And that's for 2 reasons. One, it's good for -- it's good business. It's good for Affirm and certainly, our shareholders should want that. But it's also good for the consumer. A lot of conversation these days on the consumer side. It's not a good thing for consumers to have obligations that they can't pay back, and that's a bad outcome for all involved. And when we built our business model, we started with the idea that we were going to attempt an honest and full-face underwriting effort here. And that meant we couldn't extend credit to folks who we didn't think could pay us back. We took away the lazy tools of underwriting, like late fees and reactivation fees that some of our competitors have used. We decided not to just use the traditional tools of the financial services industry. And we said, no, we're going to actually try to the thing like with some rigor around it. And what that's so important is like, okay, we have this advantage in data and how we apply it. But as much as anything about the constraints we put on ourselves in how we go do this, and that's forced us to be very careful. And that means that we just don't extend credit if we don't think the consumer can pay us back because there's not a chance for us to get that back in any way. We can't earn a late fee. We can't have a consumer flip on a deferred interest product and make up for it. These kind of lazy hacks that I think the financial services industry can be relying on. We've taken away from ourselves and proudly so, so that we have to do this well or we couldn't have built the business.

Michael, I wanted to ask you that the top real 3 things that I've gotten post earnings, and I'm sure you've heard these questions as well in the meeting, but the first one is that we got a lot was how do charge-offs are going up, but credit provisions are going down?

Yes.

I'm sure you heard that one.

I have. I think it's -- the first and most important thing to know is that denominating charge-offs by the current portfolio outstanding is just about the worst way to look at our business model. We have a lot of short duration transactions. And by definition, the things that are in the denominator on current portfolio outstanding do not include loans that have been paid back in full. Credit card companies don't have a model for this. There isn't -- we're going to take losses divided by accounts that have closed. That isn't a thing out there, but that's because they don't monetize the transactions beyond the first feed they got, we do. And the idea that you look at it on a portfolio outstanding basis, misses the point on the denominator. And second thing is, that there is a huge timing element, and it's kind of related to the first. If you think about what you need to denominate any charge-off number by is by the originations in that cohort to get a sense of on a GMV basis or on a unit basis, what the potential credit losses were in the product. And so as a result, you'd see in Q2 a rise in dollars of charge-offs associated with originations that happened about 150 to 180 days prior, which is the holiday season. Our charge-off policy is 120 days. But even setting both those 2 things aside for a second, it's probably worth a minute on how we think about the allowance. There's as you can imagine, a lot of scrutiny that we apply, that we work with our auditing partners on to make sure that we -- our approach to provisioning is correct and appropriate. And it's very data-driven. When you're thinking about applying an allowance for loan losses on millions of little transactions, it's very different than looking at just the total dollar amount and deciding that you're going to try to be a macroeconomist and forecast it. Instead, we look at the actual flow -- our model looks at the actual flow and repayments of loans. And so one thing that happened last quarter is you saw better-than-expected repayment rates on what we call the back book or the loans on the balance going into the quarter. And so the model says, well, if these loans are paying back more than we thought they were, you need to have less allowance for it. The goofy, cheesy line I have is, "We can't have allowance for loans that have been paid back". Like when they're paid back, we have less allowance. And similarly, when they charge off, we have less allowance. So it goes both ways. But as a result, the computer predicts that level of loss. And so when you see things like the allowance coming down, that reflects either a lower expected amount of forward-looking losses on the new originations in the period or an improvement in the repayment on the back book or the third case is more prepayments, repayments or charge-offs. And those factors all factor into the actual allowance calculation. And yet, every dollar of charge-offs, every dollar of allowance will eventually become charge-offs if our models are right. And the same is true in reverse. Every dollar charge-offs was captured on allowance somewhere at some point in time. unless you see obviously provisions go wildly out of line.

Got it. That's helpful. Question 2 that we got was why would a firm's approval rates go up if the lower end market was getting worse?

Yes. This is such a good question because I think it shows -- it's revealing how much more complicated our product is, and I think a lot of folks want to appreciate it. When we think about credit decisioning, it's not a binary yes or no. it's a thought process around how can we get to, yes, how can we get to an approval on that transaction. Sometimes that involves asking the consumer for a down payment. Sometimes it involves asking for a large down payment, maybe we can only improve up to half the transaction amount. Sometimes that involves changing the term lengths or duration. Sometimes that involves thinking about anything we can do with the product being offered. Sometimes you're not eligible for that longer-term 0% loan, but we can still say yes to a different product. Approval rate is definitionally just a calculus of how many -- how often we are able to approve the consumer for the transaction. It is the case that does not necessarily mean that the end-to-end conversion impact went up, but a power of ours and a key insight for everybody about how we manage the cycle is we can protect our unit economics without just flatly declining users. I think some of our competitors don't have as many product features or sophistication in how they think about the credit approval process such that they can just say yes or no. And that's just not how our Affirm really works.

Got it. And then the third one is not a new one. But as your funding instruments, how to think about that in a rising rate environment, the forward flow, the securitization of warehousing?

Yes. I'm very proud of the work that our team did in helping forecast this back in February at the Q2 earnings call in February, we dedicated a lot of airtime to thinking about how rates would flow through our business. I'm proud of it both because we were very accurate in that forecast. We feel very confident in our ability to look around the corners on things like that. And I'm proud of it because we did so on the heels of what was some of the biggest rate shocks in the past several decades. And what I'm proud to report is that our -- the guidance that we gave back in February still very much holds in thinking about the timing of flow-through of rate impact on our business. And that is to say in the very near term, the impact is very dampened. Most of our funding is not floating rate. We can manage in the near term through existing funding capacity. Our business model is a little bit different than maybe some other people who do lending, and that is we go off and secure ways to fund the business, either forward flow or debt. And then we originate loans and we do it in that order. So we're originating into more certain liabilities. And I use the word liabilities very loosely here. I'm including any way to fund the business. We originate into certain capital. And that's different than some folks who originate and then find capital for those originations. And as a result, we don't think about slowing originations. As you saw last quarter, we added $1.6 billion in funding capacity in Q4. That's on a dollar basis -- on a, sorry, balance basis, which on a GMV basis is somewhere between 2 and as much GMV capacity behind that. And so you get -- we go create that capacity, then we fund into it. And because of that structural thing, we're able to be pretty thoughtful about what rates will do because some rates will have impacts on us in the near term and some won't. And yes, new funding capacity will be a higher rate, but it's an average across the whole portfolio, and we're still benefiting from the much more benign times as we raise capital in 2020 and 2021. And so we have a lot of confidence on the timing and flow through. And we have a lot of confidence in our ability to keep executing in this market. I think it's really important that investors pay attention to our ability to continue to raise capital to fund our business. We're very proud of the success that we've had in doing that. And the language we used on the call hopefully communicated or conveyed this, that we have a lot of confidence and that, that isn't the constraint in our business at all today. The conversations with forward flow partners today are very constructive. The thing about the way we think about running the business is it all starts with creating assets that have value. If you create an asset that has value, we're confident that you're going to find people who want to either fund that or monetize that themselves. And if you take care of that, then your investors are going to be there and want to support you by buying those assets. We don't see churn on our capital base. It's a pretty rare thing. I think the only time we've churned a capital partner has been by our choice. We just don't really see that. and our capital is truly committed and folks have a hard time with that. They're like, that I can't really be committed. What do you mean by that? And it's like, no, no, really, they commit to a dollar amount, and we fund it on the forward flow side. And they're doing so because they're trying to allocate capital to a strategy that we're able to fill and deliver really good yields against. So I feel really good about that. I think the rate conversation and the associated volatility in the market probably impacts our ABS program the most, where it's just -- it's the most efficient market when it's functioning and it can also, therefore, be the most whipped around with any sort of macro context. And then again, that's not an Affirm story. Like I think the ABS market is a heck of a lot bigger than us. And clearly, the market has been impacted by the change in rates. But as we said a year ago, when we started really leaning into our ABS program and executing some really high-quality deals, I got the question a lot then. How come you're still doing forward flow, the ABS market is so efficient, why aren't you just doing ABS? And our answer then is the same answer we give now, which is -- we know that in order to build a durable and scalable capital program, we have to have multiple channels of diverse partners. And so in this environment, we're going to keep at the ABS market. We may do less marginally, but we're going to still be programmatic issuers. But we're also going to keep adding forward flow partners alongside of that. And that's going to be true really in any environment. the thing that might happen in these environments as you might tilt the scales 1 way or the other a little bit, but we're talking about on the margin impact as opposed to any sort of meaningful shift in the strategy.

And this is a little bit of a quicker answer, but it obviously came up kind of related to the topic, which was that the AFS went up on the balance sheet sequentially. So I know that comes up or came up quite a bit.

Thank you for asking, it's the most silly thing. For those of you who saw that and thought that there was something with respect to the loans, strong on 2 levels. One, remember, we have a lot of capital. So I know you also think we don't have capital, we have a lot of extra cash, so we bought some government bonds consistent with our treasury program, which you probably saw in our K. So I think the fact that folks thought the wrong thing with that, says a lot about just how much the level is of misconception about the surety of our balance sheet.

Yes. Let's talk about the Amazon relationship a little bit. Can you give us an idea of where we are in the maturity of that? And then the question we get often is that contract, I think the exclusivity piece expires next year, I think, post holiday season. Is that something that's likely to stay exclusive? Or will it be a competitive deal and that's fine as well?

I'm not going to prognosticate on Amazon's intention. What I will say is we're partnering in a really good way. For those of you who are Amazon Prime users, you may have actually received Affirm branded box during -- in and around Prime Day. We had these really cool boxes made up with our logo on it. And it seems like a small thing, but it says a lot about the depth of our partnership that we went and put together a program that was that consumer facing in our joint statement about what we're doing together. And I think there's a reason for that is that's because the fundamental alignment of interest between us and Amazon is around our consumer orientation. We talked a lot about this a year ago when we announced the early stages of this partnership. But one of the real things that matters to Amazon is how you treat the consumer. And as you heard above, we care a lot about the consumer, and that's embedded in everything we do, both because it's good business. and because of our mission, and that really resonates with them. So I'm really pleased with the joint focus on the consumer. I'm pleased with the traction that we've had early. And yet, we are in our very early days. I think we will lap the -- we will become 1 years old in November. And as we shared in the call, we're still seeing a lot of sequential growth in all of our large partnerships. And so we still feel very good about that. It's a huge channel, obviously, and a ton of TAM for us is just growing our share penetration on that one single partner. And so I feel like there's a lot of wood to chop there. So we're very early, but very pleased with the tone and tenor of the relationship, which is very constructive, very positive towards really helping as many consumers as we can.

And the other 2 pieces that when you get on Amazon recently is just the impact of the 0% offering, how that will impact the P&L? And then obviously, you have your worlds crossing here with Peloton Bikes being sold now in Amazon. Will they be offered as Affirm be a purchase option?

Yes. One of the neat things about getting to the scale and ubiquity that we're getting to, is that news like the Peloton news selling on Amazon, still allows us to continue to access those transactions. They've moved channel from direct to Amazon, but we're still partnering. And that's reflective of the scale that we have, where you get to the right ubiquity and you get to the right scale point, you're less concerned around the channel and the programs will obviously vary, the financing available will vary. But your ability to address that market survive. The 0% offers on Amazon, I would think about whether it's 0% or interest-bearing or split pay. Our product determines more of that than the channel itself. So we think about pricing 0% loans in a way to get the margin targets that we need, and that's true in any channel that we go to.

The other big win, recent win is Shopify, and that's, I think, over a year now, I guess, longer than Amazon. But can you talk a little bit about the next phase of growth there?

Yes. Again, I think there's a lot to say about the business, but also just the partnership is deep. I think we got the question before we renewed and extended our agreement. We used to get the question last year about this time about Shopify deal is only 3 years. So what's going to happen at the end of that 3-year term. I think it's a lot of folks who are applying models they've seen in the private label credit card context thinking that these expirations are going to be really big bumps to navigate around. And then we just announced a 3-year extension to the program. And so like the relationship is, I think, reflective of the partnership there. And that's the most important thing in saying all these cases because the markets are really big. And if we have a good partnership, we delight the consumers and we create margin for all involved, they think we're going to keep growing, and that's a focus for us. I think the program launched kind of the other end of the spectrum from where Amazon launch, we launched with just our split pay offering as our paying forward called offering. And that program was more or less all we had in place between the June launch and the first half of the calendar year. when we started rolling out active checkout, which is a really innovative product to kind of separate out the need for merchants to even really pick a product and begin to deliver the best financial product to the transaction type. And so we're in the early innings of that, too. Folks may not like to hear it, but it's just true like whether it's our relationship with Amazon or Shopify. These are so early. These relationships are they take years to really get to the scale that you want. And so that gives us a lot of wood to chop. We have a lot of food on the table here.

If you want to get Max to get really excited, you talked about Debit Plus. He's obviously think this could be major -- it seems though on the flip side of that, you guys haven't rolled it out maybe as quickly as at least I anticipated. And it seems to be maybe you're watching a few things before you roll it out in mask. Can you just talk about where we are in the roll out.

We have so much excitement for this product. I won't ask for a show of hands in the room, but I'm sure there are people in the room who have it. It's a really cool and innovative product for a lot of reasons. And we want to make sure that we're thoughtful about the rollout here. The last thing we want to do is get a product that isn't clicking on all cylinders in the hands of too many users. It's a new thing for us. We've never done physical anything before. So this -- we're shipping cards to people. It's a brand-new thing. And it's not just the app, which we know we can always fix, but we got to get everything right. And we don't want to set ourselves up in a spot where we were at, having launched it before it was really ready to go. And I think back to the conversations we have with the investor community around the Shopify program, if you remember, we announced that deal when we were still private in the summer of 2020, and then we went public. And I think just about every conversation, first question is when is Shopify going to launch. When is it going to launch? Why is that going to launch? And we kept saying, it's in the works. We're just testing the plumbing, this relax, it's coming, it's coming, it's coming. And then it showed up and then it was massive, and it was massive very quickly. So I think we have a lot of similar feelings here, which is we're working on it. We always wish everything we're live yesterday, but we're thoughtful on making sure we don't watch things that don't start off and continue to be able to grow and be successful. And that's where we're at with it right now. But again, not that abates any excitement that we are really thinking excited about this product.

You guys highlighted, I think, mentioned it, highlighted it a little bit on the Analyst Day, the rewards program and then Max kind of highlighted that a little bit on the call. Obviously, that could stimulate a lot of demand. The question we always get is where is that cost going to go somebody's got to pay for those discounts. Maybe you could help us think about that to the model?

You mean there's no free lunch? That's right. I got to come from somewhere. I think that we think about this as a way to be -- to drive extra engagement and to leverage the monetization path that we have in place already. So today, we operate an app where we can monetize transactions either through the usual origination of loan volume and our usual unit economics, or even where we can get paid affiliate fees, for example, to drive traffic to our merchant sites. We think the nexus of all that is where we'll be able to create enough capacity to fund the rewards program. but more details coming, just be patient.

Got it. With BNPL, as I started at the beginning, it's a new model, so it creates a lot of questions from the investment community about how it's going to hold up and what's the profitability like of this model. And obviously, you guys talked about exiting fiscal year '23, that on a non-GAAP basis, you're going to be profitable, and we kind of move towards more of the growth phase of kind of Affirm's business model, which I think is one of the slides you guys have. What's the progression from here once you turn profitable? How long will it take you in the growth phase to get to that 10% margin that you've highlighted?

Yes. I think the way to think about the 0 to 10% range that we threw out there in the growth phase is; one, there's going to be some variability quarter-to-quarter just given the timing of ramping of programs and the like. But then separately, we want to give ourselves room to keep investing. And we think the opportunity here is huge, and we're going to keep investing. I think there's a difference between wanting to get to 0 on adjusted operating income and get to profitability and wanting to make that the primary objective function as we call it, a growth measure in the business. We certainly don't intend to be a business that is trying to drive large amounts of its operating income early. We want to reinvest that in the business. But we also recognize that continued levels of operating losses are a thing that investors really are uncomfortable with right now. And so I would think of it less as, hey, how quickly can you grow the profitability in the business and more around. How do you think about investing in the business? And there it comes down to where we see the biggest opportunities. And all of the excitement you hear around our new product launches, our new geographies, our new merchant partnerships and channels. Those are areas where we're going to keep investing in as long as we see the opportunity.

Got it. We're almost out of time, Michael, but I did want to ask about M&A. I know Max's comments cut people here a little bit on the earnings call. I don't know if he was trying to do that, but I got a lot of questions on, maybe you guys are looking at M&A more seriously here.

We've been really active since I've been here at Affirm in M&A and in particular, on the eve of our IPO. We bought a business in Canada. We bought a business, Returnly. We did a couple of acquihires since then, including acquiring the engineering team from the checkout company, Fast. And so we've been very active already. And I think what Max was really signaling is if you think about our capital position, it's really strong. And as concerned as some folks out there might be, we aren't, and we're thinking more around how do we make -- take advantage of some of the valuation reset that's happened in the way to inorganically add to the business. And we think that there are assets that we would be the best natural owner for given our risk management capabilities that would allow us to be aggressive here. And yet, as Max said, there's really nothing specific or tangible to speak to. It's more just a statement of our posture, which is we feel really well capitalized and therefore, I think we can be acquisitive in this market.

Awesome. With that, we're out of time. Michael, thanks so much for being here.

Thanks for having me.