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

Good morning, everyone. My name is Dan Perlin. I head up the fintech practice here at RBC. And let me just say thank you so much for joining us today. Putting these conferences on is a Herculean task. And so as I'd like to say, we just want to land this plane today. So I appreciate everyone showing up early for this. To kick it off, I have my good friend here, Rob O'Hare, who's the Senior Vice President of Finance at Affirm. So thank you very much for taking the long haul trip to get here.

Yes. Thanks for having us.

I know you have a statement you got to get through, I think just to kick it off. So you do that and then we'll go into the questions.

Great. I'll kick off with a quick safe harbor, and then we'll dive in. So I would just like to remind everyone that today's discussion may contain predictions, estimates or other information that may be considered forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties including those set forth in our filings with the SEC. Actual results may differ materially from any forward-looking statements that we make today. These forward-looking statements speak only as of today, and the company does not assume any obligation or intent to update them, except as required by law. Yes.

Those are brutal. Those are brutal, but thanks for doing that. I guess it was required. So for many in the room that maybe don't know you as well, could you spend a few minutes in terms of your background, what you're responsible for at Affirm in terms of your role as VP Finance.

Sure. Yes, I'm a Senior Vice President of Finance with Affirm. I'm coming up on 3 years with the company. I sit on our senior executive team, and I'm responsible for 5-or-so sub-teams within finance. So I lead Investor Relations. I lead Strategic Finance, which is the team that owns all of our forecasting and budgeting. I also lead our merchant pricing team, which is the team that sets all of our go-to-market rate cards and is typically involved in some of our larger merchant discussions. I lead Corporate Development, which is the team that owns all of our whole company M&A as well as integrations of those businesses afterwards. And then I have a procurement team as well that manages third-party vendor spend.

Okay. So you wear that hats. It's a way to characterize it. So look, let's start off. We're starting off pretty much in every question session with the company's just the current state of the world, what you're seeing in particular in and around consumer spending. And if you have any kind of April and May data that you'd be willing to share with that would be really helpful.

Yes. We have some -- we haven't shared anything in terms of volume into this quarter, but we do publish securitization data and you can see sort of delinquencies, not the funnest thing to start with. And I think the health of the consumer has been pretty constant. We put out some data in our last shareholder letter that showed that we've actually been able to manage delinquencies down over the last couple of months, and we've seen sort of those trends continue in the data that's public on the securitization side. And I think in terms of spending patterns. I think that's another way to come at it. We have seen some softness in some of the more discretionary or considered purchases. So consumer electronics, some of the larger connected fitness purchases. I think there was probably some pull-in from COVID that we're still lapping against. The one area that's been really strong for us, and I think strong for others, too, is really travel. We've seen -- that's been our largest and fastest-growing category in the most recent data.

Yes. So let me just -- you started with delinquencies. We'll roll right into that. So the question is -- they actually have been trending in quite the right direction. The question is, it seems like a lot of the market is expecting the consumer to roll over, and you're not seeing that in a metric that would otherwise be kind of forward-looking in that regard. So what are you guys doing that's, I guess, creating that gap? Or is the consumer really just healthy?

Yes. I mean I think for us, we believe we have a structural advantage, right, because we are sitting at checkout. And so when we underwrite a consumer, we're not necessarily underwriting that consumer for a multiyear period, like a credit card, we're underwriting that transaction. And so we get a lot of at bats. We get a lot of chances to sort of turn the book over pretty quickly. So it's a short duration asset, and we get a fresh shot at underwriting with every transaction. And I think that served us well. We have a really high percentage of our transactions that are coming from repeat users, so consumers that we already have a relationship with. And the way that we do our credit scoring, your repayment history with Affirm informs your score. And so there's a bit of a virtuous cycle there where I think we have a broad enough [Audio Gap].

Yes. So let's delve into that a little bit more. In terms of differentiation, the BMPL space has become incredibly crowded even only in the past several years, and I know it's been around longer than that. But in terms of where it sits today, there's a lot of players. And so you guys oftentimes talk about how you differentiate yourself. You've mentioned it a little bit just there, but I think it's a bigger story to tell. So if you wouldn't mind elaborating on that.

Yes. I mean, it may seem like a simplistic answer, but I think the fact that we can serve such a wide range of average order values, right? We can go all the way down to as low as $50 on the low end, in excess of $17,500 on the high end. And I think when you put yourself in the shoes of the merchant, some of these large and sophisticated platforms that we work with, they want a single and unified consumer experience that ranges across the spectrum of basket sizes. And for us, I think that serves us really well. I think that's where we're very unique. I mean there's a lot of -- I think the competition is the most fierce in BNPL within what we call Pay in 4. And when you think about the utility that Pay in 4 brings to the consumer, you're taking a purchase and dividing it into 4 chunks, that really only over a 6- or 8-week period. That really only drives utility and leverage for the consumer at lower average order values. And so once you get north of $500, certainly $1,000, I think the competition thins a lot because there's a lot of I think complexity and sophistication that you need to bring in terms of underwriting, in terms of capital markets expertise. So I think there's a lot going on underneath the hood for us. And that range of average order values, I think, makes us pretty unique.

In that vein, as you move upstream and you think about competition, it's less BNPL, more private label, maybe. Would that be fair?

I think that's fair. I think that's fair. Yes. And there, I think that we're able to sort of run a model with merchants that is really favorable to consumers versus some of the deferred interest, some of the late fees that sort of drive margins in some of the historical PLCC programs.

Yes. We've covered a couple of private label companies in the past. So we're familiar with that. So let me hit on a point, really an announcement that happened last week. So Amazon Pay adding Affirm's Adaptive Checkout. There's a couple of things I want to talk about there. One is, maybe just walk through the difference in terms of what that relationship and product is relative to the existing relationship you have? And then I think it would be helpful if you just spend a few minutes on the Adaptive Checkout product itself.

Sure. Yes. So in terms of Amazon Pay, obviously, we're very excited with the partnership we have with Amazon. I think this is yet another way to deepen the relationship we have with Amazon. But how Amazon Pay is different than the first-party program that we have with Amazon.com or the app. I mean this is really bringing Affirm to Amazon Pay's distribution network. So these are third-party merchants that have chosen to allow Amazon Pay at checkout and now they have BNPL functionality that they can turn on as part of that relationship with Amazon Pay.

Okay. And so maybe spend a minute on Adaptive Checkout if you could because I think it's another one of the reasons why -- your engineering talent at your company is different than others and the products that you bring to market does, again, differentiate you guys.

Yes. So what Adaptive Checkout is or does, basically, it takes -- we typically present 3 options to the consumer at checkout. And with Adaptive Checkout, the first term or the shortest term is typically a Pay in 4 offering. And then we have 2 what we call monthly installment offerings beyond that. So it's basically taking Pay in 4 and monthly installments and combining those into a unified experience such that the consumer always has a Pay in 4 option that is 0 interest, if that's what they're looking for. But then they also have the ability to elongate the terms and sort of spread out the month and the cash flows for larger and more considered purchases.

Got it. Got it. And that relationship that you have with Amazon, just more broadly, is there any discussion points you'd be willing to share in terms of how it's evolved. And maybe even from when you started to kind of where we are today, I mean, it seems like you're only getting stronger, not getting more displaced as I think some people would maybe want to debate.

I think that's right. I mean I think we've gotten a lot of questions externally around the expiration of the exclusivity, which happened in February of this year. I don't want to sound capital there, but I think that was more of an external milestone than an internal milestone. There was really no change in terms of the working relationship. Obviously, you've seen us sort of expand program here recently. So yes, we feel really good about it. Obviously, it's a huge, huge platform. I think there's lots of potential for the partnership.

Yes. No, we're excited about it too. So let's spend a minute just on kind of the basics in this case, especially in the current environment. So the funding model that you guys have. You've got your forward flows, you've got warehouse facilities. You have got securitizations. So if you could just spend a minute explaining each 1 of those. And then also talk about maybe the demand in the end market for those types of products currently.

Yes. Maybe I'll start with warehouses, maybe. So warehouses, I think, are pretty vanilla. These tend to be bank-led facilities where we pledge loans to the facilities. We typically are getting advance rates in the 80-ish percent range. And so we put $1,000 of loan in so we can borrow $800 against those. I would say that, that tends to be the funding channel where we keep the most excess capacity. We're sort of -- we have a low utilization rate of the warehouse capacity that we carry. And that's meant to be a shock absorber for volatile periods like we've all experienced over the last 12 or 18 months. We can keep some latent capacity there to make sure that if there is volatility in the ABS market, we're able to fund the business. I mean that really is -- we have an amazing team internally called the Capital team and job #1 for them is to make sure that we fund the business. And so maybe before I dive into each of the channels, the most important thing, I think, is that we have a diversity of partners that really has served us well over this period of volatility that we've been in. So those are warehouses. From there, we have -- our second channel, maybe I'll talk about forward flow. So these tend to be bilateral agreements with counterparties. We typically ask for a 2-year commitment period with the counterparty. And then from there, the counterparty would sign up for some subscription amount, just making around a number, $500 million, say, for example. And then we would allocate loans to them to fill them up to that capacity level. And then because our loans pay down pretty quickly, we're doing sort of a weekly allocation to these counterparties to keep them at their subscription level. And I think there, we have a really good collection of partners that we've worked with for multiple years now in a lot of cases. And I would say that the market for bringing on new forward flow partners, I think the sales cycle has elongated because we're asking counterparties for a 2-year commitment. And because there's been so much volatility in the market, I think those discussions are just taking a bit longer. We still have a healthy pipeline of partners, but there has been an elongation of the sales cycle there.

And then has that ever happened before to you guys? Or is this more of kind of just the uncertainty that's happening more today?

Yes, it's been a market change from the last couple of years. I think 1 of the things about Affirm is we've grown so much in the last several years that we haven't necessarily been in this exact situation before. But the partners that we've worked with for a while know us and know us really well. We've continued to deepen relationships with existing partners, and it's been, just like I said, sort of an elongation of the sales cycle there. And so it's another reason why having the extra capacity in warehouses allows us to sort of fund the business with warehouses where we need to, especially as we're taking a bit longer to get these new partners over the line.

And then on the securitization side?

Securitization side, securitizations are sort of a hybrid, in my mind, between the forward flow where we're selling the loan outright. So it's effectively 100% advance rate. And then the warehouse is on the other side where it's sort of an 80-ish percent advance rate. With securitizations, we're seeing advance rates, depending on the program, in sort of the low to mid-90s historically. So it's a really capital efficient vehicle for us. There's not a lot of equity, so to speak, that we have to put into the trust. And it tends to be a bit of overlap with some of the same names that we run into on the forward flow side. So that's probably been the market where over the last 12 or 18 months, we've seen periods of dislocation where the market has just sort of ceased for a while, not because of us, but just in general. But there's also been periods where the market has been really constructive and we've issued something like $900 million of ABS paper just this calendar year already. So still a really important channel for us and one that we like and one that we expect to be a regular issuer within.

Yes. And maybe you could speak to that point, because it sounds like they're -- I've heard you talk in the past, like the regularity with which you come to the securitization market is very important for the people in the market. So maybe you could just -- since it's fintech, it's not financial services tech, I think it's helpful to just kind of explain that dynamic.

Yes. I mean, I think most companies that are accessing the ABS market do it with some regular cadence. And for us, I mean, we need to get a deal to be a certain size before it makes sense to jump through all the administrative hoops. And so we do look to access the market on a regular basis. we have a couple of different types of ABS issuing. We have 3 sort of unique shelves, we call them internally. And so we'll look to access those with some regularity, but I'm not going to commit to...

But I think it's more context...

Yes. I think the counterparties want to know that you're going to be in the market with some regularity. And also, once you launch a deal that you're going to consummate a deal, right? And so that's the most important thing for us is telegraphing to the market that we're serious about the space and that we're going to be a regular issuer here.

Can you talk about what's on balance sheet today? What's off balance sheet? And then what the dynamic is and why that changes over time?

Yes. So of the 3 funding channels, the warehouse sits on our balance sheet. So that's the primary on balance sheet funding channel. Forward flow is 100% off balance sheet, right? Those are whole loan sales. And then ABS actually sort of straddles both. We have deals that we issued that are revolving securitizations, those stay on sheet the way those vehicles work. Typically, there's a 2-year revolving period, so we can put new loans into the trust as the original loans pay down. So those work like a revolver similar to a warehouse facility. And then we have some longer-dated ABS notes that are fixed in nature, and those get off balance sheet treatment as well. Those are typically called the X deals or Z deals, lots of letters in there. And so yes, that's how we sort of mix between on and off sheet. We have moved to be a little bit more on balance sheet heavy with the sales cycle elongating on the forward flow side. And with some of the dislocation we've seen over the last several quarters on the ABS side, we have moved to more warehouse funding, and that's pushed this sort of on-balance sheet proportion a bit higher than what we've run.

How does product play into that, though? Like in terms of duration, the shorter duration stuff would seem like it's not well suited for securitization.

Exactly. Yes. So our shortest asset typically is Pay in 4, our loan products rather, and those tend to be funded on balance sheet. I think it's important to remember, if that's a 6- or an 8-week loan, our loans pay down regularly with each installment. And so you sort of divide that term linked in half to get to the weighted average life. And so you're looking at a loan product that may turn over 17x in a fiscal year. There's just not a lot of capital required to fund that business. So we're able to comfortably fund that out of our various warehouse relationships. And we think because that's such a capital-efficient loan for us, utilizing the balance sheet is easy for us to do and makes sense.

Yes, totally. So if I'm a credit buyer of the product, not a consumer of BNPL, but an actual credit buyer in the market. Why is Affirm an appealing credit product to be going after and putting in my portfolio?

Yes. I mean, I think, first and foremost, it's a very short duration asset. I mean our portfolio at large is roughly a 12-month term length. And then, again, you divide that by half. We're looking at a 5- or 6-month weighted average life. So I think short duration is really appealing in this market. And then secondly, I think the loan buyers that have worked with us, the credit buyers that have worked with us, they know that we take underwriting very, very seriously, and we have levers at our disposal to make sure that the loss cushion in our loan stays where it needs to be, so that our counterparties are making their yield. I mean, at the end of the day, folks are looking for yield. And I think to be able to get the yields that they see with our loan products, and to do it with such a short-duration asset, I think that's really interesting and really compelling for our loan buyers.

Yes. No, that makes a lot of sense. So I want to spend a second on this interplay between higher rates and pricing. And the environment that we've been in for some time now is an area of just increasingly higher rates. Your funding cost correspondingly will go up in that regard. And I think you've been moving the cap from 30% to 36%. And so I just want to talk about the dynamics of that. What does it mean for you in terms of the economic return? What kind of pressure does it put on the consumer? And is there anything else we need to be thinking about in that regard?

Sure. Maybe start with the consumer portion. I think some quick bond math for everyone in the room at 8:30 in the morning. When you take our average order value, which is about $300, and you take the average term length, moving from a 30% APR to a 36% APR, because we have regular amortization on our loans and it's simple interest, it's about a $0.75 per month change in the payment amount for the consumer. So first and foremost, do no harm, right? We don't think that we're putting a sufficient burden or an additional burden on the consumer by moving from a 30% APR to a 36% APR at our average order value. So that's really important for us. We've done a lot of testing internally around looking at repayment rates, delinquencies as we've moved from 30% to 36%. We haven't seen any sort of headwinds that come from that. So we think it's a change that makes sense for consumers and isn't going to harm them in any way. In terms of what it does for us, obviously, to your point, Dan, with the setup that we've been in with rates rising, getting more economic content into the loans that allows us to work with our loan buyers and make sure that they're able to solve for their yield and allows us to deliver the unit level economics that we need for the business at large. So it's a really important change for us. And again, the rough math is, as you go from 30% to 36%, divide those 6 points by half, and that's sort of the interest yield that you'll get on the portfolio given the weighted average life that we run. So it's a really meaningful lift for us economically.

And the merchants, because they're not seeing any pushback from the consumer, they're cool with it?

Yes. I mean the term that we use internally is that we're selling conversion, right? I mean, I think that's what merchants care about first and foremost. And because there's sort of no undue stress from this change on the consumer side, we've seen pretty good adoption in terms of rolling out the cap.

Okay. So where are you on that spectrum in terms of moving from the 30% cap to the 36%? I think the 30% was with Cross River and then I think South Bank was at 36%?

Sure. Yes.

Just want to make sure we understand like who's got what?

There's a little bit of complexity on the back end where we work with today 2 originating bank partners, one of which is Cross River Bank. They're domiciled in New Jersey. So they have a 30% APR cap. So they're not able to originate 36% loans. The large, large majority of our originations come from a Utah-based bank called Celtic Bank, and so they're able to go up to a 36% APR cap. So like I said, the majority of the originations are happening now at Celtic. And we've committed to bringing on a few additional bank partners that can also support a 36% APR program. And then in terms of the rollout across the merchant base, the stat that we shared in our shareholder letter for the March quarter had us just north of, I believe, 50% rollout across the merchant base. There's still a large merchant or 2 that hadn't gone live as of the writing of that letter, and we're in discussions. It's a really meaningful initiative for us internally to get the cap rolled out across the entire merchant base. And we don't think it's going to ever be 100% necessarily, but we've had good traction with our merchants there.

What's the dynamic to the extent that rates start to come back down? So you've created a ceiling for yourself that's gone up now once and that's kind of, I think, the high watermark. I don't think you can go higher -- maybe you can go -- I don't think like 36% is there, right?

Yes, 36% is the military lending and a cap sort of back to national cap. So we wouldn't envision going...

So to the extent that it starts to come back down and that spread positive, to your point, about do no harm to the consumer. Are you willing to kind of let that drift itself back down naturally or...

Yes. I mean I think, there's lots of different ways to -- Yes. I mean, we're thinking about it as a cap. And then obviously, the actual rate that we put in front of the consumer will be informed by delinquencies and conversion rates ultimately. And so I'm not going to hazard a guess on exactly how we'll move or adjust the rates of the consumer. But I think the question in a declining rate environment might be why are rates going down. And if it's because the consumer is stressed, then we'll have to take something like that into consideration when it happens.

Yes. That's very fair. The dynamics here between the merchant discount rate and interest income. And what I'm getting at really is that in this kind of higher rate environment, there's a return that you guys want to have, but there's also a merchant discount rate that merchants are willing to pay. And I know there are some dynamics. But what I want to get to is the interplay between those two. Like we've had these high rates. So merchants aren't willing just because you get higher rates to go after and pay a higher merchant discount for you, which kind of tends to lend itself more towards an interest APR type of product. So can you just talk through the dynamics of that?

Sure. Yes. And I think it's a really interesting question because of the sort of breadth of products that we offer, right? Like I talked a bit about the average order values that we service in our portfolio. But we also have -- we have loans that are 0 APR to the consumer, in which case those loans are being entirely subsidized by the merchant. And then we have interest-bearing programs where maybe the opposite, maybe the consumer that's subsidizing the lion's share of the economics. And so we have a lot of levers to pull and there's a lot of flexibility as a result. One of the things that we've been doing internally, which speaks to the sort of example that you shared in the question is, we've moved some of our programs that historically have been entirely 0% APR to the consumer, so entirely merchant funded, to be lower interest rate products, but still largely merchant subsidized. So an example might be taking a 0% APR program and making it a 4.99% APR to the consumer. It's still low rate in the context of the market, but it's not going all the way down to 0. And so that allows us to potentially work with the merchant to fund the program. It makes the program very profitable for us. And it's a way to sort of make it a win-win where we don't have to turn off the 0% APR because rates have gone up, but we're able to sort of clear our economic hurdles.

Yes. That really makes sense. You mentioned earlier, repeat users. I think the last number you gave was like 88%. So consumers clearly love it. The question is, with such a high repeat rate, I'm wondering like is the audience broad enough. Like it seems like you're generating an enormous success story, but that funnel maybe is smaller than we think. So my question is, what are your thoughts on that?

Yes, we still believe that it's very early. I mean, we're predominantly a U.S.-based business today. I think the U.S. is sort of mid-single digits in terms of BNPL's penetration of e-commerce. There are certainly geographies where they're into the 10% and 20%. So we think it's early. We think there's a lot of room to grow the industry at large, and we expect to benefit from that growth and to help lead that growth in the U.S. So we're not too worried about being constrained from an overall addressable market perspective. And the most important thing for us, I mean, for us as a company, for our capital partners, for our consumers even, right, is that this loan paid off. We don't want to extend credit to consumers that they can't afford. And so you've seen the repeat rates and our engagement with our existing base grow because those are the consumers that we know best, and those are the consumers that we have a structural advantage underwriting as a result.

Yes. So one of the concepts that I think is starting to come out a little bit more now is this product innovation versus profitability of the business. In profitability, not that long ago, really wasn't that long ago, people just didn't care, and now they very much care. So how is that influencing your product road map? Where you can make investments? And what kind of hurdle rates you actually have to have in order to attain profitability in the spectrum that you've already called out for people?

Yes. We did set the marker out a couple of quarters ago that we want to exit this fiscal year. We're a June fiscal year. So again, we're in the last month of the fiscal year here. We did want to exit on an adjusted operating income basis and be breakeven or better. I think we're still very heads down on that mission. And with that, it does mean spending less on product and engineering on a relative basis. And I think that's created a constraint internally, and I think that's a healthy thing for us. So we feel good about where the cost structure is and our ability to execute on that goal.

Yes. One of the products, I think, was Debit+ that kind of maybe was caught up in this...

No, sorry to interrupt. But no, I think Debit+, we're still -- yes, it's a product that gets a ton of attention internally. It's one of the bigger bets that I think you'll see us -- that we've made as a company and it's still very much front and center and very important strategically.

Good. That's good to hear. We had some questions, I think, past the last call about how that dynamic is going to play up with you guys. So I'm glad to flush that out. We got 30 seconds. So one of the last things I would just give you is you tend to be the kind of enterprise BNPL provider of choice, pretty dramatically so. And so what's the difference? Why can't others support Walmart and Amazon and Shopify, and the list is long, and you guys seem to win all of that business? Not that there's not shared economics around the industry, but you guys seem to tilt in that way?

Again, yes, I think it's that breadth of average order values. It's the product and technology sophistication that we bring to these partners. As big as all those programs are, they're also very different from each other, right? And so I think, ultimately, merchants want a partner that they know is going to be there for them long term and can serve a lot of different types of transactions.

That's awesome. We've got a great story in an environment, I think people are waking back up to it again based on what we're seeing. So thank you, Rob. Really appreciate it.

Appreciate it.

Awesome. Thank you.