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

All right. Well, I guess we should start. Hi, everyone. I'm Jason Kupferberg, the payments processors and IT services analyst here at Bank of America. We're very excited again, as was the case last year, to have Michael Linford. CFO of Affirm with us. Lots of ground to cover. We've got 30 minutes. Thanks for being here as always. We appreciate it.

Thank you for having me.

Of course, I wanted to give you a chance to maybe first talk about -- you've had a couple of press releases the last 2 days. One was about Amazon Pay and a firm becoming an available instrument in that wallet and then today about the authorization to buy back the convert. So maybe if you want to just hit on both of those to give us your perspective on what investors should really appreciate from those announcements.

Yes. I mean I think it's just more of what we've been working on here at a firm. We laid out our -- starting with the convert, we laid out our capital priorities in the shareholder letter a few quarters ago. You saw us last quarter chip away at it. And we continue to look at that as a smart thing that we can do for the shareholder to manage that liability proactively. We've been running with a pretty strong amount of what we call dry powder not [indiscernible] Of AP term, but it's how we think about a view into liquidity in the business. And we have a pretty strong position there, and we obviously have a lot of conviction for what we're building and think that practically managing that liability is a smart thing for the shareholder. And so it's tactically a smart thing for us to do. And the feedback we get convert investors we talk to suggest that they would also receive that pretty well. With respect to Amazon and the Amazon Pay announcement, again, it's more of what we've been working on with them. We talk a lot about the pride we have in being able to work with a world-class retail institution like Amazon and we talk about the depth of relationship and how we work together to solve problems for consumers. And the outside world wants to look at the contract and all those things. And internally, that's just not same. We're focused on making sure we can expand our offerings to as many consumers as possible. being able to get off of Amazon.com and support other merchants is exciting to us, finding more avenues of distribution for our product. We talk about the 60% of U.S. e-commerce that affirm is available on. It's a good news, bad news thing, where 60% is a great number, but it's 40 points short of 100%. And so one of the ways we get that 100$% is we find ways to get our product distributed with partners who understand what we do for consumers and can offer that product proudly. And we're very excited to continue to do that. And I think it's more than anything, a testament to the continued work we're doing with Amazon on behalf of merchants and consumers all over the world.

So merchants who currently accept Amazon Pay as a form of payment would basically have the option to add a firm as a payment method, right? That's essentially how it will work?

That's it. It's obviously super important because it's with the world's leading largest retailer, but also online there, but also, it's part of our consistent strategy to find ways to get distribution. And we're excited to get back to talking about those parts in our business, especially since that's always remained what we're focused on.

Yes. Do you think it moves the needle on GMV in fiscal '24?

I think it's important. It's important like all the things are important.

And then collectively, they all add up, right?

Yes. I mean one of the things that's, I think, underappreciated a little bit is just how important the full distribution is for things like repeat rates. So for consumers who use the product once they are delighted by it, they actually have to have an opportunity to see it again for them to use it again. And while we have a strong and a lot of latent opportunity in our direct-to-consumer business, the ways we can drive those real network effects that we see in our business, they're tethered to the distribution, part of the reason we're so excited to have the partnerships we do with the world's largest e-commerce players. But in the words of one of my former executives, more is more. And so we're definitely focused on getting more distribution.

Okay. A firm has a really good lens into consumer discretionary spending, younger, call it, maybe lower to middle income kind of cohort. Just curious what you've sort of seen from that cohort as the quarter has progressed, just given all the moving parts and uncertainty in the macro, which you may have read a little bit about?

Yes. in Max's shareholder letter, he talked about all of the unprecedented events that have happened over the past couple of months and the joke internally is we're just waiting for the alien invasion as the next thing that [ Nanavati ] had on their radar, and it feels almost that fictional the number of things that have happened. We've been experiencing an unprecedented rise in rates and associated macro response to that. You've seen banking failures both as a result of that, but also I think as a result of taking the eye off the ball a little bit on some basic risk management practices. And that like it's a lot of volatility all and with the consumer who is feeling the pressure of inflation, but maintaining really strong employment. And for us, it's really the same. It's more of what we've been seeing throughout the beginning part of this calendar year, which is the consumer has clearly changed their financial situation from where they were a year or 2 years ago, but the resiliency and employment has really allowed them to continue to be really perform it on credit, our delinquency trends, both what we report for the portfolio, but also our delinquency trends you see in our ABS data remain really strong. And that's because we believe the consumer is fully employed and we're able to identify and price risk correctly in this environment and that we think will continue. We've stopped internally talking about the change in credit outcomes that we saw about this time last year. A stressed -- the word stress a lot, but it's no longer stress it's just the norm has been reset and we're running the business at a new level. And you're still seeing the same trends with, I think, some green shoots, but the same trends around the shift away from larger discretionary purchases and towards basic staples. That's obviously a trend in the consumer is experiencing and going through. And yet, we're talking to some folks earlier that the strength in sectors like travel remain really strong. And that's in large part because a lot of deferred travel that folks had been pushing out, and we expect that to continue to be strong for us for the foreseeable future.

Maybe we can -- just reflecting back on March quarter performance a bit. Revenue, GMV, you had a pretty nice beat and raise there. In fact, I think you raised the guidance for this fiscal year by more than what you beat the quarter by revenue less transaction expense, there were some other dynamics going on, right? And I think that the beat didn't quite flow through. And so maybe just for the benefit of everyone walked through some of that, there's some funding mix considerations and so forth. But maybe you can kind of lay that out and walk us through the pieces.

Yes. We're really excited for what we feel is both pockets of reacceleration of GMV growth, increased consumer engagement. We're excited for things like our Debit+ program and where they're going to go, all of which has us feeling a lot more excited about the growth prospects in the near term. We've always had excitement about the long-term prospects, but we knew that we were having to manage through a tight window here and feeling really front-footed there. And yet, the capital markets remain extremely difficult to navigate right now. The team that we have doing the work is the best team in the industry. I was speaking to them than yesterday, and I say it a lot, and I believe that we're really good at this. And yet the market remains a difficult one to operate in. You have the combination of higher rates, which has been discussed ad nauseam, and I would encourage folks to go back actually to the last time you and I are together on stage. We talked a lot about the rate environment. And I believe the then forward curve expectation of rates was something on the order of 200 basis points. We all think that's acute now, and we forget how quickly it's changed. A year and a few months later, we're a very different universe. But alongside that, credit spreads have also widened and they widened not for us specifically, but across almost all asset classes. And that's really because a combination of making sure that the premium is appropriate for the risk that they're taking, but also a general sense of credit uncertainty that's out there. And I would speculate, I guess, share an opinion that I think when you have multiple large banking failures, it doesn't do good for credit committees thinking about risk that they want to take. And that's not a specific thing to us, right? But that backdrop...

Indirectly, yes.

Makes it a difficult environment to operate in. And so what does that mean for us? For us, it means that we're going to continue to use funding strategies like our warehouse lines and consolidated ABS deals, it means that we're going to have less growth in our forward flow program. And that does change the shape of the P&L in a given period. But I think it's important to separate that from the asset that we're creating. And think about our model as we create an asset and then we fund it. The asset we're creating continues to get more value in it. We've been excellent on credit outcomes over the past couple of quarters. I think our credit performance stands out in high contrast to almost any other unsecured consumer risk-taking institution. And I think our -- while our funding costs are going up, so is our ability to price and our efforts on alleviating some of the APR caps that we have for our merchants has allowed us to continue to earn enough revenue to offset that. So we feel really good about the asset that we're creating. So think about the return on that asset, the economic content that you get, I feel really good about it. And yet, the shape of the P&L and the funding strategy is going to vary a little bit. And then lastly, like, look, we're -- any quarter that you expect to see sequential growth in GMV like we're forecasting for our fourth quarter. You do expect there to be a little bit of a lag effect because of the timing of how we report out those revenue less transaction cost numbers, it's heavily influenced by the timing of the growth in GMV. And so you saw that play out. Our Q3 results were really strong. We're really strong in part because we had a really strong Q2 that showed up down the P&L in Q3. And so you would see the same thing play out where the Q2 results, I think folks were concerned with, but the Q3 results were stronger. And I think you're going to see Q4 sequential growth in GMV, which is going to suppress a little bit where Q4 is going to be, but it's going to create value for the P&L throughout the course of next fiscal year.

Okay. So let me maybe pick up on that with revenue less transaction costs since it's obviously a very closely watched metric. And you guys have been very consistent since the time of the IPO, you said 3% to 4%, 3% to 4%, and you went above it, obviously, during the pandemic, right, and you told us all it was going to normalize and you were right, they normalized. Looking forward, I think you've continued to say with a high degree of conviction, you can operate in that range in pretty much any macro scenario. So just like a little two-part question, like, a, what sort of gives you that confidence and visibility to stay in that range? And then b, just hypothetically, if you were to fall below that range, what would be the most likely reason for that to happen?

Yes. So thank you, and I think we have been consistent, and we were running at 4.5%, I got the question of, shouldn't it be higher? And we said, no, 3% to 4% is a good number. And we've had quarters and we would expect to have quarters that may dip below that number and maybe even periods of time where you're on the lower end of that but that doesn't take away from what we think is like the fundamentals there. And the fundamentals are that we produce an asset that's really valuable. And we have a lot of levers at our disposal to generate the level of unit economics that we need to build a profitable high cash flow business, which is what we're all about. The biggest drivers in terms of like one quarter swinging up and down is really around the balance sheet strategy. And so as you think about less gain on sale and more loans on the balance sheet with the provision for credit losses happening at the time those loans go to the balance sheet and you think about earning the interest income over the life of the loan, it just creates this skew where you got a lot of costs upfront, no revenue upfront and a lot of revenue happening later. And this is a thing you saw in our second fiscal quarter. And it's a thing you should expect to see in Q2 is probably for the foreseeable future where our second quarter is going to have a lot of origination starting in Black Friday and through December, end of quarter originations, which amplifies the effect even more alongside of a sequentially growing quarter, which amplifies the effect again. And then you layer balance sheet usage on top of that, and you get this vertical P&L, the actual P&L report in the quarter as being very different than the quality of the asset that you produce. And when you're able to sell more of your production to forward flow partners, all those dynamics go away. You produce an asset, you sell it, you book your gain and you go on to the next quarter. But those dynamics really do factor in heavily on your balance strategy. So quarter-to-quarter, that's the biggest driver. If you think about over the longer term, the biggest driver of why we wouldn't be at 3% to 4% is mix in our business. So we talk about 3% to 4% as being a function of having some businesses like our monthly installment products that can be more like 4% to 5% in some businesses like our PAy in 4 business being 1% to 2%. And they average out to 3% to 4%. Obviously, if we mix more towards higher velocity Pay in 4 businesses, you'd expect that number to be lower. Additionally, we've talked a lot about how Debit+ will change the math, and we're going to do some work to communicate how we think about Debit+ GMV, the pay now GMV, which we do not expect to be anywhere near 3% to 4% on a margin standpoint, given that pay now GMV is maybe as a point of revenue on it, 3% margins are possible on that.

Right. Right. So why don't we go to Debit+ arguably your most prominent new product right now. It sounds like it's kind of ready for prime time as we go into fiscal '24. Just walk through the value proposition for the consumer, for the merchant. Maybe any kind of update on this kind of initial rollout that's been proceeding in the last couple of quarters and how will the investment community to be able to track the progress of Debit+?

We are so excited about this product. And that's the thing that I know we've been saying for some time, but...

Max has been saying for some time.

Max has been saying for some time.

But now you're joining the chorus.

I am now very much in the same camp for the excitement. Let me talk about it for why it matters to the network that we're building, why it matters to consumers and why it actually is a cool thing for merchants as well. So why it matters to our network? Today, we primarily serve considered purchases online. And so we have a frequency that while it's growing at a really healthy clip is well south of the kind of engagement that you'd expect with kind of primary payment methods that consumers use. And so we know our frequency is not where we want it to be, and we want to continue to focus on that. Our network also doesn't extend itself easily offline. So while you can use affirm off-line, we sure make it difficult for the consumer to do so. And by giving the consumer a try and true payment method that doesn't require apps and bar codes and clogging up the checkout line as you fill out your affirm request. You give them a payment method that is truly seamless to the physical world experience, which is tapping an NFC chip or swiping a card. That opportunity for us and the unlock for us is huge. We talked about why distribution opportunities like Amazon Pay are so exciting to us, so is getting our product into the physical world easily. That's obviously an asymmetrically large portion of retail generally. It's also an area that's benefiting from the post-COVID resetting and normalization of online, offline trends. and our product means just as much to consumers in that mode. And so for frequency, for offline engagement, we just think it's really compelling. It's also the best way to use affirm. I'm obviously a heavy user of it. So our -- most of the management team, as we like to make sure we use all products a whole lot. And it's a substantially better way to use the product because you separate out the need for using the app from the actual last mile, and it's a great experience. So that's why it matters to us and why we're so focused on it. For the consumer, they get to take the purchasing power that we give them transaction level purchasing power that we give them and apply it to a much wider set of transactions with almost no friction. We have a product today. we refer to as our direct-to-consumer virtual card product. It's not what we call it internally, but that's what we talk about it externally. And what that product is, is you open up our app, you apply for a loan, a purchase amount, we go through all the process we create the loan. We then generate a onetime use virtual card number. And then we do something that is so frictionful. We ask the consumer to copy the card number, the expiration date and the three-digit code into the checkout flow online. In the store, if NFC is working, and you can use it with some of the digital wallets that sometimes the cashier has to type in the number. And like each of those steps are terrible and all that just disappears. When consumers talk about the card and why it's so powerful is. It's everything affirm does for them delivered in a form factor that is just easy to use. And that's really exciting. And it's more than just one of those things, right? So it is the payment method that you can use at your debit card for your groceries and your cups of coffee that you wouldn't ordinarily want any purchasing power expanded with but it's also the card that you can use to get purchasing power. And you can do it in a way without revolving. You remember, the thing that the consumer gets very quickly about the product that I think investors are slower to get just because we live on the coasts and generally aren't the profile of users who are revolving on credit accounts, they do not want to revolve. They love the control that they get out of transaction level credit. And that to them is a huge important feature. And we're giving them the things that they love about that while still being a very easy-to-use everyday use card for the daily transactions. Consumers love it for that reason, we can extend the purchasing power in more modes for them, and we can take out a lot of friction for them. Merchants love the product because it requires no integration work for them. And every merchant invariably wants us to create a solution for in-store. And then you start to get into all the complexities of the how, and that can show up as like something as simple as just a sticker on the checkout wall and say, go download the app and then generate a virtual card and all that friction I mentioned comes back and it is in play, and you're jamming up the checkout line, or you can generate a QR code and have it be scanned by the register. It requires a huge technical lift from everybody involved. And oftentimes, also jams up the line because the consumer still has the application as seamless as it is, it takes time. This takes all that away. We can talk to somebody in a marketing department who wants to offer a payment for a product in the store and can't get prioritized in the technology road map at that merchant and we can be like you can market the product. You can tell consumers we can go help them understand that we can deliver the cool features of buy now pay later, pay in 4 monthly installments, you name it and requires really no lift for them. And so it's about being able to give consumers what they need to be able to purchase what they want without having to, frankly, fight for IT resources, which is actually a really hard thing for the larger enterprises who are most concerned with the online to offline trends, yes.

Okay. So when you guys give fiscal '24 guidance, will there be kind of a carve-out for Debit+?

I'm not going to make any promises about fiscal '24 guidance or otherwise at this point. What I will say is we've been consistent. We want to help investors understand what the relative contribution we want to help investors understand how important the pay now piece is. I think for the portion of the card that's lending today, we don't break out that direct-to-consumer virtual card product, even though it's a very big business for us. It's also a business that's been accelerating for us. We don't break that out, and I'm not sure that we will for the card. I'm not sure about that yet. But I do know we'll tell you for the debit portion, give you some sense of how much of that pay, we call it pay now, but the stuff that is on the card only for 24 or 48 hours. And that's really important because coming back to your question around the revenue less transaction cost, we need to make sure people understand the impact that, that has on the number, which obviously will drag it down and we don't think it's just to be painfully repetitive. Our 3% to 4% range did not include pay now business in that range.

Okay. Okay. Got it. So basically, the consumer is going to essentially be linked back to whatever their existing checking account is with this Visa branded card?

Yes.

Very familiar.

I missed that.

No, it's okay. I just want to maybe...

Yes. No, I really appreciate that. Thank you. I missed that other piece that's really cool for the consumer. We're asking them to change their account. They certainly can open a savings account with affirm today, and we would love that. But we don't make that a requirement. It's not a requirement to have an affirm demand account in order to use this product. And that today looks like either we call it linked and unlinked, you can have your account linked to the card in which we can offer you more products and features. You can also operate unlinked, which still just delivers that same credit product that we have in the app in a physical form factor. And so while that's really compelling is we're asking the consumer to like change their whole financial life. We're asking them to begin to use the financial product that we think sits on top of and leverages their existing financial life and you have a checking account with large money is the bank, great, keep it. So you don't need to change that.

Right, right. So easy for consumers, easy for merchants. Okay. Right before we started this year, now we're talking about the P-word, profitability. It's becoming more prominent to use another P word. And you've talked for a while now about achieving sustainable positive adjusted operating income, really, I guess, exiting this month, right, which is the end of your fiscal '23. So you clearly seem on track to do that. But can you give everyone a sense of how you're just broadly thinking about the longer-term potential trajectory of adjusted operating income margin?

Yes, it is upon us. We've had several quarters in our history where we've had brief moments of adjusted operating income positivity. And the real focus on us right now is making sure that we're getting our operating expenses levered appropriately with the growth in revenue in the business so that we can do that on a sustainable basis. And we're happy with the progress that we're making and there's no sense that the work is done. We very much have a lot of work to do to live up to that commitment that we've made. And so the team is focused on it and will remain focused on it. The -- from there, we haven't made any commitments as to how we think about profitability trending from that point and certainly not going to today. But then we can begin to talk about how we think about investments in a slightly more rational way. So if you think about our history over the 4.5 years I've been here, we've always been invested well ahead of the business. And we really didn't take a lot of time to think about what is the level of profitability that we want to reinvest in the business because we were obviously running at a negative operating margin for most of our time. And so what I think we'd like to do is think about paying to profitability and getting to thinking about what level of investment makes sense? How do we think about the specific opportunities that we want to invest some of that positive margin into and what do we think is important for us to continue to grow for the shareholder. We're not interested in giving up on the opportunities that are in front of us. So you're going to see us continue to want to invest a healthy portion of this because we think the opportunity set remains really big. And so we're going to want to create space for that, but we're also going to want to be mindful of showing investors that we say we have confidence in the long-term operating margins of this business. in its cash flow generation profile at scale. We want to make sure we're giving investors enough confidence that, that path is something that we're actually on and it is just something we believe.

Okay. That makes sense. We've been getting some more questions about with student loan repayment, starting back up pretty soon here. I'm sure you guys have been thinking about that. Do you anticipate any material impact either on GMV or delinquencies?

So we're not currently very focused on the first order impact that it's going to have with us. We feel really good about our ability to control credit. We think that things happen, they definitely could impact us or anybody, and we need to react to it. But given the short duration of our asset, we're not sitting here saying, let's tune the decisions today for a thing that might happen in the future. We can be a lot closer into it. And that being said, I do think it is -- it's on our list of things that we're looking at from a macro standpoint that do -- that we're paying close attention to. The consumer remains fully employed today and healthy in that respect, despite some of the pressures on them. But it's not so perfect that they couldn't withstand any shock. And so we're mindful of what impact that may have on the consumer more broadly, and we're certainly going to take that into consideration on how we run the business going forward.

All right. With that, we're out of time. Thank you, Michael. Appreciate it.