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

All right. Good morning, everybody. Thanks for joining us. kicking off the second day of the Morgan Stanley TMT Conference here in San Francisco. Thanks to everybody joining us in person. Before I get started with the team from Affirm, just quickly for important disclosures, please see Morgan Stanley research disclosures website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to any Morgan Stanley rep. So I'm James Faucette, senior analyst at Morgan Stanley. I'm one of the -- well, I'm very happy to have with us today President of a Affirm, Libor Michalek. Hopefully, that was close. All right. And then Rob O'Hare , SVP of Finance. So thanks to both of them for joining us today. And -- and as we go through the next 30 minutes, I'll remind people, but if you have any questions or things you want to follow up on, please just raise your hand, we'll get you a microphone and we'll take questions from whoever is here in attendance.

So let's start with big picture, Libor, is that before -- what do you think are the biggest misperceptions that investors or others have, such as customers or regulators or incumbent banks. What are the misperceptions that you think are out there around the Affirm today?

Well, first of all, thank you for having us. Really appreciate taking the time to have us come out and talk about Affirm. I think the biggest misperception is around the -- that we are more than just a Pay-in-4 company. Our ability to offer more products, to have a wider set of products. In fact, we started with a longer-term monthly offering. That's really where our underwriting and credit shops came from. And as we've built that out, we've continued to expand to cover wider range of purchases and as a result of wider range of customers, both on the merchant side as well as the consumer side. That is powered by our closed network of -- closed-loop network where we're underwriting and looking at every single individual transaction, which means we're able to price on a transaction basis, merchants, consumers and even the brands that the merchants are selling, able to bring all of that together to create the best possible offer for the customer and the merchant as well. The -- and I think probably the last piece of it is the consumer friendly consumer alignment. We really think about it as aligning with the interest of the customer. So that when the customer does well, we do well. When we do well, the customer does well. So that means really making sure that the customer understands what they're getting upfront as a part of making the purchase that the decision that they're going to make has all the information that they need about how much this purchase is going to cost them, all in, it will never be more. It will never be different than what they've agreed to. And that is an important element to making sure that we stay aligned with them, continue to deliver value and make sure it's the most honest financial product out there.

Got it. Got it. So when we talk about like all of those aspects, there's alignment, et cetera, from our perspective, we think there's actually a really important demographic opportunity in the U.S. in, whether that's being Gen Z or younger millennial customers and BNPL generally and the Affirm product seems to be a great way to win at least some of those customers and give them the opportunity to start to build their first credit transactions and history. But how does that align with where you see opportunity? And I guess if that makes sense to you, what is Affirm -- how can Affirm retain those relationships with those consumers as they age and mature? And one of the points that we often make is that people say, "Oh, these younger customers are not good customers," I don't know, like, they're not great today but eventually, some of them will be great customers, right? And so what is Affirm -- what can you do to attract those and then retain them?

I think -- well, ultimately, it's a matter of ensuring that we have product offerings that really cover the range of what the customers are looking for. And so you have the smaller transaction size Pay-in-4 for Gen Z. But then as they matriculate through improving their finances, being able to cover a wider range of purchases allows us to cover a wider range of consumers. And we see that in the demographics. So we certainly have a pretty wide breadth of people who find honest financial products compelling, find the offerings compelling. So for us, it's a matter of continuing to develop our product offerings to cover a larger space of where it is applicable and relevant to the consumer, to be able to cover more consumers. So this is where Debit+ really comes in and our investments there to be able to serve a lot wider range of purchases.

Got it. Got it. So on Debit+, is that -- do you envision then most of those customers coming from and maturing from like the initial BNPL? Or is Debit+ an attractive product to bring new customers in by itself? And what do you think that mix is going to look like?

I think that's -- it's still early in the testing in the life cycle. We do think about it as the product we want as people get to know what the -- what Affirm offers, how it can help them. Debit+ is really where we see that journey leading. I think there are certainly compelling opportunities that we're discussing with merchant partners where that could also be the on-ramp, especially through those partnerships. But we do think about it as, okay, this is where we want to get customers to because it really offers the widest range of flexibility to them.

So I think both Max and Michael have been fairly upfront about the Debit+'s scene. Like, there's been some hiccups that probably weren't anticipated and getting the economics right and making sure the product is well understood, et cetera. Can you tell us a little bit more about what those -- describe what has happened there and maybe why that development has been a bit slower than had been expected, at least when initially announced?

Yes. Well, from my seat, I always anticipate hiccups. So I think that's -- from my perspective, it's expected, especially with what's happening with Debit+, where we're trying to balance our access to the merchant network, the consumer product and ultimately, the economics of it and how to align all 3 of those. As we're thinking about folding it and as we're executing on folding it into the core offering from the test offering, making sure that it works well with all the existing products that, for example, that onetime use virtual card that we have on the super app that is -- that's the performance relative to that is really compelling. And at this stage, on all 3 fronts, we're really excited. It's performing really well through the merchant network. Consumers get it and use it at a higher frequency than in any of our other products. And on the economics, it's performing ahead of expectations for us internally. The things that we're starting to see with it is, this wider range of usage. So a lot more usage in the in-store, offline world, where the existing products are used in a more limited fashion, but we're seeing a lot more velocity, a lot more usage across a wider range of products. So I think we're going to be talking more about that towards the end of the fiscal year, specifically in numbers, but it's very exciting right now.

So we -- having anticipated the hiccups, as you said, are that being part of your job. Like what are the key things that you've had to address? And in order to get to this stage where now things seem to be functioning well on at least those 3 key assets?

I think the -- probably the biggest pieces has been around explainability to the consumer, right, where you have this hybrid product where you can use it for -- and we want you to use it for every single purchase, but you can also use it to plan your large purchases, where you know ahead of time. This is a purchase that is larger than my biweekly cash flow, I want to plan for it. I'm going to want to pay for this TV over time, understanding that dynamic in the app, making it really easy to understand and explainable. And so encouraging users to plan for those big purchases and how that then connects into the merchant network, into the economics and be able to kind of manage what is ultimately a new product, a new concept and making sure that it resonates with consumers.

Right, right. And what has or -- I know you talked about like providing more details as we get towards the end of this fiscal year, which is the middle of the calendar year. But what should we be anticipating in terms of -- from Debit+ this year in terms of promotions, generally activity? And also, you talked about the economics, how -- like how should we think about that in terms of relative to Affirm's general economics?

So on the promotion side, today, we have 14-plus million active -- annual active users. So the rollout is really going to be initially focused on them. So that is going to be the first stages of how we roll it out and how we introduce it to different consumer segments and get it out. And that's going to be really the focus of the next couple of quarters as we start to develop also, again, the merchant piece of this as well and then the new user piece as a follow-up. So that's where we're going to be focused initially. The second piece of it in terms of expectations on economics, it does -- so I think what we will see is larger repeat rates, so when we think about repeat rates those will be increased, there -- I think what we're going to see, obviously, the nature of the product is, right? They're bifurcated. They're bifurcated into pay now transactions, which sit on top of interchange and really kind of flow through the product. And then you have the Pay-in-4, the installment loans, the interest-bearing components of it, those economics will look very similar to our existing products.

Got it. Got it. That makes sense. Speaking of the -- how does the economics and APRs, et cetera, that was a big topic, obviously, at the end of the last quarter and in the conversation around earnings, et cetera. What has been the progress then, on rolling out the higher APR caps among merchants? And how are those conversations evolving?

You -- Rob, you have.

Rob was ready for this.

I got the numbers. I mean I think we're excited about how it's rolling out.

Yes. I think what we shared in the last earnings call was that we rolled out a 36% cap to about 23% of our interest-bearing program and so that's important. I think it has the potential to be -- as we go from a 30% APR cap to a 36% APR cap, it has the potential to be very meaningful to our business overall. About 2/3 of our overall volume is interest-bearing. So it's really applicable. And when you do the rough math on -- we've got about a 6-month weighted average life. So if you take the 6 points of cap increase, divide that by 2, you're talking about 3 points. And then you multiply that by the 2/3, right? So it can be really, really impactful to the overall P&L.

So with that new higher cap, like what about from an approval perspective, like how much does this improve your approval rates and that kind of thing, do you think?

It's going to be case by case based on the merchant and the profile of the customers that are showing up at the merchant. But ultimately, from a theoretical perspective, we want that last approval to be sort of breakeven for us, maybe slightly better. And so by having more economic content in the loans, that does allow us to [indiscernible].

Right, right. But in terms of like backtesting, saying, oh, if we would have had this cap, like we would have been able to improve x amount more? I mean is that something you share with us?

We haven't shared those values publicly.

Okay. Got it. So maybe I'll take a breath here and see if there are any follow-up questions on things that we've hit on so far. All right. So talking about applications and approvals, et cetera. I think many were pretty surprised to see that around 38% of $1 billion a week in application volume is actually converted into GMV. And look, there can be a lot of reasons why applicants don't convert beyond just whether they're approved or not, right? Like whether the promotions or the terms aren't compelling enough, maybe they're just really only window shopping, if you will, those kinds of things. But how should we think about where that number has been historically and maybe more importantly, where Affirm would ideally like to be and be able to capture more of that inbound demand?

That's actually a really difficult number to sort of speak to completely in aggregate across all the products, given the variability across different -- all kinds of different merchants. It's certainly a number that we look at and it represents an opportunity. It's not something that we expect to be 100% or 90%. It's largely driven -- there's everything from window shopping to approvals, which is only a part of it, to the product offering as well. And this is sort of when we think about the products and where we're making investments, making sure that it's a relevant offer to the consumer and really building that out because that's certainly a piece of it and so we'll see, I think, as the product continues to mature, a wider range of offerings that are possible and the more appropriate offer is made to the consumer at that point. And through that showing increase in that number in aggregate.

Got it. Got it. And then in terms of -- for people that don't convert either because they're not approved or because they decide not to convert even on an approval, what is that -- one question we've had is like how much brand friction does that introduce? Like how often are you seeing -- or how willing are you seeing people be it, they come back and reapply if they were declined or if they were approved and then decided not to convert?

Obviously, as you would imagine, it differs between approved and didn't -- decided to go do something else with their time versus a declined. The approved ones very resilient to come back on a regular basis, whether they've taken up or not almost at a very similar level of return. On declines, it's actually quite robust. I think the consumers, especially ones that have obviously used the product before, understand that, that's part of the offering. This notion of consumer-friendly alignment. It means that we're going to sometimes tell you, yes, this -- the amount here is too large. The, right -- this doesn't make sense relative to the rest of your finances. And so are quite resilient to come back. Obviously, if we continually decline them over and over again, if there is a decay to it. But on sort of the initial ones, it is a quite high return rate. We also strive to -- a lot of it comes across as not taking up versus straight-out declination. We strive to put forward some offer. And that's where the consumer has the decision, is that compelling versus not. So things like variable size down payments, asking for more information from the consumer, which gives us more confidence on the risk side that they will actually be able to pay. It also creates a better experience for the consumer since it's not a straight-out decline.

Right, right. So as part of that approval process, one question I've had is like, obviously, especially for initial transaction or even a second transaction or so on, is that -- there is a lot of value in looking at like, okay, what kind of transaction is this, what's the purchase like, kind of purchase specific underwriting. But over time, if you do multiple transactions, like how important is that weighting versus the individual?

That weighting on the transaction actually becomes really important for pricing more than for approvals for repeat customers. For repeat customers that are repaying us on a regular basis, obviously, in good standing, the risk profile, obviously, is improving. That generally on average actually is pulling the pricing that they get down. There's then the transactional level pricing where the merchant and the brands are able to sponsor things like 0%, make that a more compelling offering. So that is where the transaction data really on those repeats starts to matter.

Got it. Got it. Got it. That's helpful. And then looking at merchants, we publish every quarter a proprietary tracker that looks at the acceptance of many digital wallets and BNPL providers across the largest online merchants. And we found a good portion of the new merchant growth at Affirm and other BNPLs, is with merchants that already have another BNPL provider. So how should we think about Affirm's ability to keep gaining share among the largest retailers? And how are they positioning the different BNPL providers within their offering?

Well, I won't speak to what they're doing. From our perspective, the way we're approaching it is through continuing to expand those offerings that we're able to make. And make sure that we're putting the best offer in front of the customer versus our competitors where they have more rigid offerings -- more rigid capabilities. That is both in terms of what the consumer is seeing, making sure that it's the right term length, the right pricing, the right offer that is fitting their finances as well as from the merchant's perspective, right? Is that -- in the way -- what they're paying for. They're paying for conversion that they're getting it, right? Is that they're -- as they're putting in dollars to subsidize things like 0% and other fixed APR offers that they're getting the most for, their conversion and that, that budget is actually optimized for as wide of a range of customers where that incremental dollar towards the transaction is actually going to be the thing that converts. And so from the merchant's perspective, that's where they see better approvals with Affirm, higher AOVs, higher cart sizes relative to competitors, and that really is where it starts to matter.

So how active is your engagement with the merchants? So as to communicate like, okay, this is what we're doing and demonstrate the higher levels of approval or bigger purchase sizes, et cetera, so that you can maintain position?

Yes, very. Obviously, it depends on the merchant side. One of the things we're excited about, some merchants are hyper-engaged in working with us to look at the data and tune the offering, not even just within their surfaces, but even as they go into their advertising, into their ad spend, looking at the funnel as users come in through different, through different surfaces and how that -- how those users convert through the funnel and what the offering is across those different ingress points. For us, one of the exciting offerings on the merchant side that we're working towards is taking the learnings from the most engaged merchants where we're doing this and actually pulling it into the self-service product. So that is the long tail of SMBs can really access that functionality in a self-service, automated fashion.

Got it. Got it. So I want to turn to costs and profitability, et cetera. There's been a big mix shift in Affirm's business to more interest-bearing loans from partners like Amazon as they've grown as a proportion, et cetera. And that's created some noise in the P&L as interest income is earned over time, but costs are realized upfront. So it creates this margin impact, at least initially. When -- how should we think about that evolution? And is there a point at which that trend reverses and that greater loan balances of loans paying interest actually becomes a positive for margins?

Yes. I'll speak to that. I think it's important to remember that Amazon is roughly 1/3 of U.S. e-commerce, right? So as much as it's become our biggest merchant, it's also -- we still think we're underpenetrated there relative to what the long-term potential is. So the dynamic and Amazon is largely an interest-bearing program today, right? So as we continue to scale there, I think the dynamics that you're talking about, where you're getting your income over the next 6 or 12 months, that dynamic is going to continue until we sort of normalize and slow down the growth with Amazon, which we hope never comes. I think that dynamic is important. There's also a funding mix dynamics that drives the effect that you're talking about as we're holding more loans on balance sheet, we do need to wait for the economics to flow through the P&L over time. If we go back to selling a higher proportion of our interest-bearing loan production, then we are able to take more of those economics in period. And also we don't have to provision for those loans. So it's a mix of both, the mix of loan types, but also the funding mix is really important.

Got it. Got it. And then obviously, margins turned the conversation to profitability. And this is probably the area where we get the most frequent questions, is around the profitability targets. And the target that has been set out to be run rate profitable this year or exiting this fiscal year. It's -- but at the same time, it's a really dynamic macro environment with a lot of uncertainty around that. So just wondering like how you're building confidence that you can exit this year? And aside from the headcount reductions that have been announced, what actions are you taking to achieve this? And how has progress been so far?

Yes. I mean Libor can speak to this, too, but we've really started to -- not started, but we've deepened our focus on internal profitability drivers. So getting as much of the portfolio as we can to 36% is a great example. There's of course, a bunch of operational things on the back end that come with that, that we need to run through and it took us a bit longer to get there than we had hoped. But we're really aligned on that. We're focused on continuing to optimize and drive the large programs that we have. And then we're taking a hard look at sort of all of the OpEx envelope and trying to be as efficient as we can. And I think the fact that we've narrowed our focus a bit more to be, again, more inwardly focused on profitability, I think that sort of -- that compounds the benefit that we expect to see in the P&L.

Got it. And then as part of the contributor there, credit performance is obviously an important focus for investors and the one that they monitor from the outside, especially in the current environment. And we've seen Affirm's reported delinquencies stabilize in recent months. But can you remind us how you think about controlling credit performance? And is Affirm shorter-duration loans help as we know? But do you have targets such as the [ Q rate ] percentage that investors should keep in mind? And what are the other aspects of credit performance that you're monitoring right now?

I mean that's what -- so delinquency is just one aspect of what -- and it's -- we think of it internally as a sub metric, really what we're targeting from the investor -- right, the debt investor side -- the performance of the loans, is the yield. So as we think about different pricing, both in terms of, on the merchant side as well as the consumer side, as we're increasing to 36%, we're focused on that -- the economics of that ultimately lend and making sure that delinquencies match what we're targeting in terms of putting out, the duration help. We're able to -- what we're offering to the consumer, obviously, pull those in, bring -- pull those in, push those out, that's just one of the levers of many that lets us set targets.

I would just add, I mean, because we have such a broad range of loan products, a loss rate that works in a 36% loan may not work in a 0% APL loan, right? So we really need to look at the transaction itself and we're solving for sort of that return for that loan itself.

And so on a like-for-like basis, are you seeing then ongoing deterioration or what we're seeing externally is that really representative that it's stabilizing? Or what is happening right now?

Well, the consumer is stressed and the level of stress is relatively stable, but that becomes an input into exactly what we're putting forward in front of the consumer. So for -- like as an example, a consumer at the margin where -- as Rob said, where it's maybe at the breakeven margin, what we will do in that case that's different than a year ago, would be things like put a down payment in front of them, shorten up the terms, maybe instead of a 12-month offering, make it a 6- or a 3-month offering. And that really normalizes that incremental stress. And so those are the tools that we're deploying. So that as we -- the internal metrics that we're targeting remains stable.

Got it. Got it. And then the other side of the equation is obviously funding. What is the funding environment right now? It seems like it was a little bit suspect at least in -- at the end of the year, calendar year. And then it did seem like there was a little bit of reprieve from that in January, in the early part of February. But how are you seeing the funding environment right now? And what are the pressures that you're feeling around that?

Yes. I would agree with your framing. We found this first calendar year or calendar quarter to be a lot more constructive than we found Q4 of last year, so much so that we priced a $500 million ABS deal. I think we were the first consumer ABS deal of the year. So we've definitely taken advantage of a bit more of an optimistic funding market. And at the end of the day, I think the ABS market is indicative of where our forward flow partners are too. That's our largest funding channel. And I think the forward flow partners have seen the strong credit performance, and that gives them confidence. And so we've been able to maintain those relationships, in some cases, grow them. And we're -- yes, we continue to be sort of optimistic and feel like we're able to fund the business in this market.

So when we go back and look at like kind of the targets that you've given is like with growth, coming down to roughly 26%, I think, is your target for this fiscal year in terms of GMV growth, et cetera. Where are the pressure points? I mean, is it funding limitations? Is it, you guys restricting the credit box a little bit more aggressively in order to manage performance? Or is it consumers pulling back and not seeking credit is off and et cetera? Like, where is that balance right now?

Yes. I would just be really clear, we haven't tapped the brakes because of funding, like funding has never been a constrain, it -- theoretically, it could be, but we've never gotten close to that line.

You see you have none close to that?

Yes. So yes, I think the points that you listed are the right ones. There is definitely a slowdown in discretionary spending with consumers. That's real. I mean you can see that in our data, things like home furnishings have slowed, consumer electronics has slowed pretty meaningfully and even connected fitness has slowed. I think in the most recent quarter, we lost about 8 points of growth just through Peloton alone, a large merchant for us that has a pretty meaningful slowdown. So it's important to keep that context in mind as we think about.

So just in the last minute here, Libor is, what is kind of your key to-do list right now? Is it like, you obviously have products and product fit for the customers, retaining customers? There's the merchant engagement side of things, like where are you focused? Or how are you prioritized?

I feel like you just read the road map, actually -- the big focus is managing credit performance, managing consumer performance, rolling out Debit+, getting that out, especially to start to tap into in-store and offline to broaden that offering and focusing on consumer engagement. So the consumers that we do have, making sure that they find the product compelling for more and more purchases and are returning.

Got it. Got it. Well, Libor and Rob, thank you very much. That's all the time we have. Thanks, everybody, for joining us here.

Thank you. Thank you.