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

My name is Zane Keller and I'm Director of Investor Relation. Joining me for today's call are Rob O'Hare, our Senior Vice President of Finance; and Ben Director, a Senior Manager on our strategic finance team. The purpose of today's session is to give analysts and investors a better understanding of the financial and accounting drivers of our business. We are not providing any updates to our outlook today nor are we disclosing any historical financial information beyond what has already been publicly disclosed. Today's presentation will have 3 main sections. First, a walk-through of our revenue less transaction costs, or RLTC. We will also discuss potential approaches to forecasting RLTC and the main drivers of RLTC. Second, we will walk through the components of our operating expense base and the drivers for each. Within this section, we will also discuss the drivers of share-based payment expenses. Lastly, we will wrap up by discussing some final considerations to take into account when modeling our business. In order to make this session more interactive, we will pause for questions and answers after the RLTC walk through and again at the conclusion of the session. We estimate that the session overall will last about an hour, depending upon the amount of Q&A. As a reminder, today's session is being livecast and both the replay and presentation will be available on our Investor Relations website after this meeting. Before we begin, I would 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. In addition, today's call may include non-GAAP financial measures. These measures should be considered as a supplement to and not a substitute for GAAP financial measures. Reconciliations to the most directly comparable GAAP measures can be found in our earnings supplement slide deck, which is available on our Investor Relations website. At our RLTC walk through, we will cover the interplay between revenue and transaction costs. and how these 2 come together to generate RLTC. We will also suggest 2 approaches to modeling RLTC, discuss the main drivers of RLTC and address potential challenges to forecasting RLTC. You could consider 2 approaches to forecasting RLTC. Under the bottom-up approach, in which your goal is to forecast individual revenue and transaction cost line items, you would begin by forecasting GMV by product. Next, you would also need to forecast GMV by funding channel to arrive at an on versus off balance sheet mix. Once you have both the product and funding segmentation of GMV, you could then forecast revenue and transaction costs to build up your revenue and transaction cost estimates. Under the Second top-down approach, you would simply forecast GMV and consider various drivers that would shift RLTC as a percent of GMV up or down compared to prior periods. This [latter] approach has the advantage of being simpler, though it is less detailed. Overall, we believe that the 2 approaches complement each other. Before we delve into the 2 approaches, we will first discuss the main drivers of product mix and GMV growth. We generate GMV from 3 main types of products: interest-bearing installment loans, 0% APR monthly installment loans and pay in 4 or transactions which are split into 4 biweekly payments paid over 6 to 8 weeks. Over time, our product mix has shifted towards interest-bearing installments and away from 0% APR products. In part, this is due to the addition of late calendar year 2021 of a large enterprise partner that generally only offers monthly interest-bearing products. Additionally, we previously generated a meaningful amount of 0% APR GMV for Peloton. We observed a significant reduction in GMV with Peloton as the pandemic subside. Our GMV growth is influenced by both structural and temporary drivers, which we have listed here. We encourage you to take these drivers into account when forecasting GMV. If you decide to take a bottom-up approach to estimating RLTC, it's also important to estimate the mix of RLTC that is retained on balance sheet or sold off balance sheet. This is because funding decisions impact both revenue and transaction cost line items. We disclosed the portion of loans sold during any given period in our 10-Qs and 10-Ks. As shown here, within any given quarter, we have sold loans equivalent to roughly 35% to 55% of GMV. The actual mix is driven by funding market conditions and our GMV growth rate relative to funding capacity additions. Once you forecast total GMV by products as well as the amount of GMV retained on balance sheet versus loans sold, you can begin forecasting individual revenue and transaction cost line items. We monetized our business through 4 revenue streams: network revenue, interest income, gain on sale from loans that we sell and servicing revenue. Due to the previously mentioned change in product mix, our revenue mix has also shifted over time. We will discuss this mix shift as well as the drivers for each revenue line item on the next slides. The 2 main drivers of network revenue are first, overall GMV and second, the product mix between pay in 4, 0% APR monthly loans and interest-bearing products. We discussed the impact that product mix has on network revenue as a percent of GMV on the next slide. The network revenue that we earn as a percentage of GMV, also known as the merchant discount rate or MDR, varies significantly by product type. For example, long-term 0% APR loans have a volume-weighted average MDR above 10%, while interest-bearing loans have a volume-weighted average MDR of approximately 2.5%. As a result, product mix shifts can have a significant impact on overall MDR. In general, we have seen 2 clear trends in recent periods. First, like-for-like pricing within any given product has been stable over time. Second, overall GMV mix has shifted towards interest-bearing loans, which have a much lower average MDR. As a result, overall MDR has gradually declined due to product mix shift. You should take this into account when you forecast network revenue, but also consider that our lowest volume weighted average MDR by product is approximately 2.5%. On this slide, we show our interest income over time and as a percentage of average loans held for investment. The main drivers of interest income are the proportion of loans funded with on-balance sheet, warehouse and ABS securitizations and the blended APR of those retained loans. The mix of interest-bearing GMV versus 0% APR and pay in 4 loans will determine the blended APR of the portfolio. Similar to interest income, gain on sales of loans also reflects funding decisions we make after a loan is originated, namely, whether we decide to retain the loan on balance sheet or sell it to a third party. As an example of a way to [indiscernible] being on sales of loans, you could take your estimate of off-balance sheet [TMV] and then make some assumptions about the gain on sale as a percentage of loans sold. Factors that impact the actual gain on sale as a percentage of loans sold include funding market conditions, the interest rate environment, the average APR of loans and more. Finally, our smallest revenue stream is servicing revenue. We earned servicing income for loans held off balance sheet that we continue to service. The main driver of this revenue stream is the absolute size of our platform portfolio held off balance sheet. To model servicing revenue, you can estimate the off-balance sheet portfolio and multiply it by some assumption about servicing revenue as a percent of off-balance sheet platform portfolio. Your estimate of off-balance sheet GMV should directly impact your estimate of the total off-balance sheet portfolio. With that, we have covered our 4 revenue streams, and we'll now move down the P&L to transaction costs. As we generate GMV and revenue, we have 4 transaction cost streams: Loan loss provisions, processing and servicing expense, funding costs and loss on loan purchase commitment. We will discuss the main drivers of each of these expense streams on the next slides. Overall, transaction costs as a percent of GMV have been largely stable over the past 2 years, but we have slightly increased in recent quarters due to the higher interest rate environment and the higher proportion of loans held on the balance sheet. Before we discuss our provision for credit losses, we would like to describe how we set our loan loss allowance and how this ultimately flows through to our provision expense on the income statement. The allowance we hold for loan losses is set at the time of the loan origination based upon the credit risk of the transaction. We believe that loan loss allowance as a percent of loans held for investment is the best measure of the credit risk that we are taking. As loans mature over time, some portion of them become delinquent. After 120 days of delinquency, we charge off the remaining delinquent loan balance against the allowance set aside for loan losses. As a result, the provision for credit loss expense is an output of the allowance that we set at the end of the period plus the charge-offs during the period less the allowance at the beginning of the period. In other words, the provision expense is downstream of our allowance. As discussed, the realized provision expense reflects loan loss expense associated with new and existing loans retained on the balance sheet. Thus, while provision expense is generally correlated with the growth of retained loans, significant swings in expense can occur on a period-over-period basis. When modeling provision for credit loss expense you could, therefore, consider beginning with an assumption about our end-of-period allowance rate as a percent of loans held for Investa and solving for the provision expense. You can also check this figure against GMV, less loans sold during the period. GMV is by far the main driver of our processing and servicing expense. A secondary factor is the mix of GMV coming from a large enterprise partner, which has a revenue share agreement. The mix of GMV originated from this partner increases as it has over the past 2 years, processing and servicing expense will increase as a percent of GMV. The main driver of funding cost is the dollar amount of average warehouse funding debt plus on-balance sheet securitization notes. We have a mix of fixed and floating rate debt facilities our warehouses are floating rate facilities, mostly tied to [Sofr] while our ABS securitizations are structured with fixed borrowing costs. Our average funding cost is a function of benchmark interest rates plus credit spreads. Over the past year, both have increased due to increases in benchmark rates, plus increased volatility in the funding market, which has led to higher credit spreads. Loss on loan purchase commitment is an accounting concept, which applies primarily to 0% APR loans that are originated by a bank partner like [indiscernibel] Bank. We have a contractual obligation to purchase all loans originated on our platform by our bank partners at par. When we purchased the 0% APR loan at par, we booked a loss on loan purchase commitment to reflect the GAAP discount required to reduce the loan's carrying value down to reflect the appropriate fair value at the time of origination. The main driver of loss of loan purchase equipment is therefore the amount of 0% APR loans originated in a given period, multiplied by some assumption about the markdown required at the time of origination. As an alternative to forecasting individual revenue and transaction expense line items, you could consider a top-down approach to forecasting RLTC. Using this approach, you would forecast overall GMV and then make an assumption about RLTC as a percent of GMV to produce your RLTC forecast. At a high level, there are 2 categories of factors that influence RLTC as a percent of GMV. The first category includes a firm and BNPL industry-specific dynamics. These include the impact of our pricing initiatives, product and merchant mix shift and product efficiency improvements. Overall, we estimate these factors were a slight tailwind during the first 3 quarters of fiscal year 2023. The second category includes macroeconomic factors such as consumer spending trends, funding costs and the consumer credit environment. Holiday buying seasonality is another important consideration especially when forecasting quarterly results. In total, we estimate that macroeconomic factors were a significant headwind to RLTC as a percent of GMV during the first 3 quarters of fiscal year 2023. To recap, we have outlined 2 approaches you could consider when forecasting RLTC. Under the first approach, we began by forecasting GMV by product and also by on versus off balance sheet mix. You then estimate each individual revenue and transaction cost line item to arrive at an estimate for RLTC. Under the top-down approach, we forecast total GMV and then focus on the factors that could shift RLTC as a percent of GMV, higher or lower versus prior periods. Overall, you should take into account several considerations regarding RLTC. First, macroeconomic factors have been a significant headwind to RLTC as a percent of GMV during the first 3 quarters of fiscal year 2023. Second, affirm's specific factors have been neutral to a slight tailwind during that same period. Third, our pricing initiatives, particularly 36% APR will take several quarters to achieve maximum benefit. Finally, RLTC as a percent of GMV is highly seasonal, with the second fiscal quarter being seasonally lowest. Well, we've covered a lot of material, and we promise that the next section will be shorter. With that, we'd like to pause here and begin a question-and-answer session for questions specifically relating to RLTC. For those of you participating in the webcast, you can either raise your hand and ask your question live or submit the questions via the Q&A box. You can also e-mail us at [email protected]. We will pause for approximately 1 minute to collect questions.

Great, everybody. Thanks, again for joining. We're going to go ahead to begin the Q&A session for RLTC. And again, if you have any questions, please smit them via the Q&A box or alternatively, you can e-mail us at [ir@affirm].com. We're going to begin with 1 of the questions submitted via the Q&A box. So James Faucette from Morgan Stanley asks, how predictable has the mix of products become for you internally? how long is your visibility into win at which merchants may offer 0% pay-in-4 or interest-bearing products. Rob, do you want to take that.

Sure. Yes. Thanks for the question, James. For the most part, merchants don't make significant changes to their financing programs on sort of a month-to-month basis. We do have some large merchants that will use things like 0% offerings on a promotional basis. And we have done some work internally within the portfolio to move some programs that we're pay-in-4 for only to be adaptive checkout, meaning it's a pay-in-4 offering and typically a monthly installment offering alongside. So there's been some structural changes that we've made internally. But for the most part, it's pretty constant. And obviously, we have a wide variety of merchants that are growing at different rates. And so the mix will fluctuate a bit given that dynamic as well.

Great. Thanks for the question, James. Turn to one of the live questions. Eugene from Moffett. Would you like to go ahead and ask your question?

I didn't know which way is better. Can you talk a bit about the best way to forecast charge-offs because I'm thinking about the credit allowance calculation and appreciated the point that you guys made the best ways to think about the allowance as a percent of loans and then kind of calculate the expense from that, but the other piece is charge-offs if I'm thinking about it correctly. And I was hoping you guys can speak to that a little bit.

Yes. I think just given the nature and the timing of when charge-offs occur on our platform, they have been 120 days after the first delinquency. For the most part, delinquencies are -- tend to be front-end weighted within [alone], so relatively close to the origination date. So I would look -- I would sort of build a cohorted view of on-balance sheet GMV and then time lag it by something like 150, 180 days. I think you can see a bit of a clear relationship if you were to sort of play with the charge-offs that have been reported versus the GMV that was originated.

Great. [indiscernible] go ahead and turn it over to Mike from Goldman Sachs. Who wants [indiscernible]. Great, Any other questions about RLTC ladies and gentlemen? If not, we can go ahead and move on to operating expenses. You will have a chance again, at the end of the operating expense section and then the conclusion section to ask additional questions if you would like. And so you can ask about RLTC or anything else you like. But for now, we'd like to focus on just our RLTC [indiscernible] you have any questions there. Click mike or ethan, can't raise his hand one more time, so let's try.

I'll throw in 1 more. high-level question. Can you talk a little bit about -- and I think it's pretty simple. I just wanted to confirm, when you -- when the share of the loans you keep on all balance sheet changes, how does that impact RLTC. In other words, when you're keeping more on the balance sheet, does that automatically all else being equal, make RLTC higher?

Yes. So maybe it's a bit of a nuanced answer. Thanks for the question. So I think you should think about it in terms of maybe RLTC in the period of GMV origination. And then I think you should also think about because we're, for the most part, originating 12-ish month loans. You should also think about RLTC on more of a lifetime or a horizontal basis. And so when we keep the loans because we're not sharing the economics with a loan buyer, that's obviously a more profitable activity for us. And so in the long run, retaining more loans will increase our RLTC margin or RLTC as a percentage of overall GMV. However, given the timing and the mechanics of the accounting for retained loans, we do book what is one of the largest expenses against a loan, which is putting that allowance, that initial allowance on and that will flow through as provision expense. And so that dynamic does create a bit of a J curve where in the period of origination, a monthly installment loan of, say, 12 months, for example, would be -- would potentially be negative RLTC in the quarter of origination, even though it's likely to be a very profitable loan if held to maturity over a 12-month period.

I think we had a question from John [Coffey] from Barclays. If not, I think you also submitted the question via e-mail. So we also received a question via e-mail from a different questioner or how does the 2026 senior convertible note buyback impact forecasted share count? Really a question more for the second section. But Rob, you might wanna answer that? How does it impact the forecasted share count or does it?

Sure. I typed in an answer in the Q&A section, but just for folks on the call or on the phone. We really haven't forecasted share counts that assume a conversion of the convertible bonds. The conversion price for the bonds is roughly $215 per share. So we're not anticipating today that those bonds would convert into shares. There would be about, I think, 8 million shares against the bonds based on the original issuance size. We have bought back a bit of the face value in the March quarter. But so short answer is they're not anticipated to convert and therefore, aren't included in any of the share count forecast.

Great. We got another question via e-mail, again this is from John at Barclays. Can you walk through the quarterly cash flows from 0% APR loans as well as interest-bearing loans.

Sure. again, I think the cash flows are going to depend a bit on the term length of the loan, right? We do range on the monthly installment side. from 3 months on the short end to 60 months on the long end. But just taking maybe a 12-month example for both 0% and interest-bearing in a 0% loan, right, it's 0% APR to the consumer, obviously. And so all of the cash compensation that comes to affirm is coming from the merchant relationship. And so in terms of the cash flow obviously, there would be the cash outlay for the loan itself. So the loan amount would go out the door to the merchant. We would then net the merchant's discount rate, the fee that we collect from the merchant against that principal balance, we would settle that net. And then we would book an allowance against that loan, and that's -- again, that's a noncash charge for us, so not necessarily a cash flow hit but then we would just collect principal repayments from the borrower over the 12 months of term. And so assuming the loan pays off, we would just collect the full principal amount. If you were to take a cohort of view, there would be some losses typically in a loan cohort. And so that would just reduce the amount of repayments that we would collect from the consumer. The other sort of cash charges that would show up as we're making those -- as we're collecting those repayments from the consumer would be things like payment processing costs, right, whether the consumer pays us back with an ACH bank transfer or if they use a debit card, right, those will have different cost profiles for each of the repayments that are made. And then also any sort of customer support burden, we do run call center support for our borrowers. And so we allocate a charge to the loan book for those activities as well. Those tend to be sort of semi-variable. They're a bit more fixed and sometimes difficult to allocate down to a loan-by-loan basis, but those would be some of the other transaction costs that would show up. And that all assumes, of course, that we're holding the loan to maturity. If we weren't holding the loan to maturity in a 0% example. We would sorry, the piece that I missed is that we hold the loan at fair value. And so there's also an upfront noncash expense that we call loss on loan purchase commitment, which Zane walked through. And that would help build a discount that would set the fair value for the loan. And then if we were to sell that loan to a third-party loan buyer, the loan would be -- the gain on sale would be booked against that reduced fair value. And then -- sorry, and then the other sort of expense that I missed on the loan that's held to maturity would obviously be the financing cost for the loan itself. We typically see advance rates for on-balance sheet financing. That's about $0.80 on the dollar against the principal. And so there would be a charge for the funding costs against a subset of that balance. And then for an interest-bearing loan, a lot of the mechanics are similar. Typically, we would receive a merchant discount rate upfront in cash. So that would be a cash inflow. Again, that's netted against the settlement to the merchant when funds are dispersed for the loan amount at the purchase time and then we would hold the loan to maturity. And so we would receive a bit different than the 0% example, we would receive both cash and principal payments from the borrower. Those are the way our loans work, there's typically a monthly amortization. It's a fixed payment amount. So the first repayment has a larger proportion of interest than principal and then the last repayment would have more principal than interest or the way that a mortgage works. And so the balance would pay down on a month-by-month basis. We would have funding costs against the principal balance that's outstanding similar to the 0% example. And then, again, assuming -- depending on what you assume for loss rates, the loss rates would show up in -- on a cash basis, they would show up in reduced repayments on an accounting basis, they would all -- the expectation for losses against the loan would be all booked upfront as a noncash charge.

Great. Thanks very comprehensive answer. I think we'll have time for maybe 2 more questions. So we'll try to Mike again at Goldman Sachs and if Mike isn't available, we'll go to John Hecht at Jefferies. Mike, your line is open if you want to ask it. I think he's not there.. Okay. John Hecht from Jefferies.

Okay. question I'll get a little echo, so I apologize if I sound a little discombobulated. But it's the gain on sale margins, obviously, one component of modeling that is the mix of loans sold versus [gain on sale]. But the other is going to be the [indiscernible] itself, which is predicated on interest rates and interest rate benchmark interest rates, interest rates in the marketplace. Interest rates on the loan and so forth. So taking all those considerations, how do you think you should count for that in the model?

Yes. I mean I think we showed the trends in terms of gain on sale versus, I believe, we showed it against the loans sold, the average loan sold balance. And so obviously, there has been a compression as we've seen rising rates, John, to your point, right, the yields that our loan buyers need to achieve have gone up. And as a result, the gain on sales pricing needs to go down for them to achieve those yields. I would say the offset that we expect to help sort of alleviate that downward trend is really sort of getting more economic content into the loans themselves. And so the way that we expect to do that is through the continued rollout of this 36% APR cap that we've been speaking about for the last couple of quarters in our shareholder letters. And so if there are higher coupons or more economics in the loans, that will help us sort of maintain or even raise loan sale pricing as we've sort of reset to this new rate environment.

And do you generally use the forward curve and the basis for your guidance when considering gains?

Yes, that's right. It's not, I would say, because these are bespoke bilateral agreements, it's not always a truly floating rate assumption for the gain on sale, but it's informed, of course, by the forward curve and also informed by just the relationships and the color that we're getting from our capital team, which owns those relationships with the loan buyers internally for affirm.

It looks like we have answered all the questions we had in the queue. As a reminder, if you would like to ask additional questions, you will have an opportunity to do so at the conclusion of today's session, we have 15 minutes or so for Q&A.

Now that we have covered RLTC, we will explore these 3 components of our operating expense base and the drivers for each component. Because we tend to look at expenses on a non-GAAP basis internally, we will begin with non-GAAP expenses, but we will later touch on the reconciliation to GAAP expenses. Our 2 largest operating expenses are tech and data analytics and general and administrative. Due to our efficient go-to-market motion, sales and marketing expenses are relatively low as a percentage of GMV and have declined in absolute terms in recent quarters. We have exhibited the most operating leverage on the sales and marketing and G&A lines in part because these expenses are not directly correlated to GMV or the number of active consumers. Tech and data analytics spend has scaled more directly with GMV. This is because some of the tech and data spend is related to infrastructure spend, such as cloud computing providers as well as consumer credit reports that scale with our loan application volumes and a number of active consumers. As many of you know, we have a substantial GAAP operating expenses tied to share-based payment expenses. These share-based payments are primarily tied to 2 categories. First, employee stock compensation expenses, including our CEO Value Creation award; and second, enterprise warrant and commercial asset expenses associated with equity and warrants that we provided to 2 enterprise partners as part of our commercial agreements with them. We believe that the accounting for share-based payments is one of the more misunderstood parts of our business. Under GAAP, share-based payments are added back to shareholder equity. As a result, the main impact of share-based payments is dilution rather than any change in overall shareholder equity. With that in mind, we do not expect to see substantial declines in shareholder equity over the coming years. For example, since fiscal quarter 2021 our shareholder equity has actually increased from $2.4 billion to $2.5 billion despite us incurring substantial net losses. [Surely], in our most recent quarter, shareholder equity slightly increased sequentially even as we recorded a $206 million net loss. Another complicated part of our business is our enterprise warrant and commercial asset expense. These expenses stem from commercial agreements we have with 2 enterprise platform partners. As part of the commercial agreements, the partners agreed to accept affirm as a payment option and separately also agreed to a certain exclusivity period. We remain in the commercial agreement period for both partners even though our exclusivity with one partner ended in January. For both partners in exchange for entering into the commercial agreement, we effectively granted the partner a block of our shares known as a commercial asset. Under GAAP, we take the fair value of the commercial share grant at the time of the issuance and amortize it over the life of the commercial agreement. This is a fixed expense over the life of the agreement. For the enterprise warrants, we take the fair value of the warrant at the time of grant and amortize it as certain performance-based conditions are achieved. As a result, the enterprise warrant expense is more variable in nature. Importantly, we expect total enterprise warrant and commercial agreement expenses to decline substantially as we exit fiscal year 2025 or approximately 2 years from now. This should lead to a substantial reduction in our GAAP share-based payment expenses. The last component of our share-based payment expense is employee stock compensation, including our CEO, value creation award. We would like to emphasize that we set stock-based compensation based upon an annual share dilution target. We do not target a certain level of GAAP stock-based compensation expense. One component of stock-based compensation expense is the CEO Value Creation Award that we granted at the time of our IPO. This award consists of stock options with a $49 stock price that are strike price, excuse me, that are earned when our share prices exceeds certain thresholds for a 90-day period. Importantly, additional stock options under the CEO Value Creation Award will only be earned if the 90-day trading day [VWAP] of our share price exceeds $132. With that, we have reached the conclusion of our financial model information session. Before we go to Q&A, we would like to mention some final considerations that you might take into account when modeling our business. First, you can consider focusing on forecasting RLTC rather than other income statement or balance sheet items. This is because RLTC has a significant impact on our operating income and can be complex to model. When forecasting RLTC, you could consider using both bottom-up and top-down approaches. You can also consider taking both the affirm specific and macroeconomic factors that affect RLTC as a percent of GMV into account. Second, we walk through some of the recent drivers of our non-GAAP operating expenses. In general, we have demonstrated good non-GAAP sales and marketing and G&A expense leverage. On the other hand, tech and data analytics expense has scaled to a greater extent with GMV and customer growth and therefore, we have delivered less operating leverage on this expense line item. Third, with respect to our share-based payments, we target a certain amount of annual share-based dilution. We do not target a certain amount of GAAP share-based compensation expense. Additionally, the incremental vesting of the CEO Value Creation award options is subject to high share price thresholds with the lowest threshold being at $132. Finally, we have a substantial amount of share-based payments associated with our enterprise warrants and commercial asset agreements. We do expect these expenses to decline substantially towards the end of fiscal year 2025. Thank you all for joining today. We hope you found this session informative and we will now move to our final question-and-answer session. For those of you participating in the webcast, you can either raise your hand or ask your question live or submit the questions via the Q&A box. You can also e-mail us at ir.affirm.com. We will pause for approximately 1 minute to collect questions.

Great. Thank you all again. Back to our Q&A session. So we did receive a few questions via e-mail, and we also have -- [least] want to [tend you] with his hand up. The first question we received the e-mail was for Mike at Goldman Sachs. He asks, First, can you please remind us what loan types are self-originated versus originated via bank partners? Second, can you talk about the impact of self-originated loans at a loss that are accounted for as a contra revenue to MDR? Is that a material amount? Ben, did you want to take that one, actually?

Yes, I'd be happy to. So on the first piece, just around which type of loans are self-originated versus bank partners, basically anywhere we legally have to go through a banking partner. So essentially, in our U.S. business, all our installment lending comes through originating big partners and then all are pay-in-4 for loans, so the shorter kind of 6- to 8-week term length 0 interest loans are actually self originated out of our own fully owned subsidiaries and then all of our international lending is done by self-originated arrangement. In terms of the second piece around kind of which are recognized as contra revenue that is largely immaterial right now. It's basically only on the pay-in-4 and our international volume, which was quite a bit smaller. And you would think of that somewhat as related to what we would need to do for the loss on loan purchase commitment if we were to originate ourselves.

We received a question in the q&a box from [indiscernible] -- is it fair to look at the interest income from an interest margin perspective, meaning interest income minus funding cost as a percentage of GMV or loans. Rob, do you want to take that?

Sure. I think that's totally a fair way to look at the business. We tend to look at the business a bit on a bit more comprehensive basis where we factor in all of the consumer interest, but also the fees that we receive either from loan buying partners or from the merchants as well, and we tend to look at the total revenue against the total transaction costs. By looking at sort of how the yield or the net yield has trended where you're looking at consumer interest against the funding cost, I mean, that's completely appropriate as well.

Great. Thank you. It looks like we have a question from John [Coffey] again. I think it was -- John, your mic is unmuted now or should be able to unmute at least and ask your question?

Yes. Are you able to hear me this time? Perfect. I was just wondering if you could walk me through your thought process about what goes on the balance sheet, what goes off? Is it a simple decision? Is it -- I just kind of wonder what factors go into that decision.

Sure. Yes, this is a question that we get quite often. And so thanks for asking it here. I would say that there does tend to be sort of a predetermined mix that ranges by loan product type, I would say. So the easiest example is a pay-in-4 loan that is or 6 or 8 weeks long in duration, probably has a 3- or 4-week weighted average life. We typically don't sell those loans at all. And so they tend to stay on balance sheet because there's not much capital required to support a pretty sizable loan book, right, the loan a pay-in-4 loan would turn over roughly 17x a year. So we tend to keep those loans on balance sheet and they sit in a warehouse facility. I would say, on the opposite end of the spectrum, long-dated 0% APR loans from a consumer. So some of our programs go out to 48 or even 60 months on the 0% side. We tend to sell the majority of that volume because the only compensation that we're typically receiving is from the merchant, that's collected upfront. And so it doesn't make sense for us to sort of hold those loans to maturity over a 3- or 4- or 5-year basis. So we tend to sell a very high proportion of that elongated 0% loans. And then I would say, for our third loan product, interest-bearing, it's going to be a function of sort of the forward flow or the loan buying capacity that we have, and we typically know where a loan is going to go at the time of origination. We're not pooling loan originations and then making an allocation decision later. We have a pretty regular allocation process to our loan buyers. And we keep a close eye, obviously, on the capacity that's available as the loan balances that our loan buyers are holding amortize down on a daily or a monthly basis. So it's a pretty mechanical process in terms of allocating a subset of the book on the interest-bearing side to loan buyers. We do that on a weekly basis.

John, do you have any other questions?

No, that was it.

I'll pause for maybe another minute to see if there's any last minute questions. Looks like I'm here about. Let me find where your hand is here, maybe one second. Apologies.

Okay. Sorry, I just wanted to -- Rob, can you clarify that last answer a little bit. I guess, the part, if you know at the time of origination, where the -- I guess, where the loan is going. Yes. How does that -- I mean, I guess what I'm struggling a little bit with is, it seems like there are times when you -- whether you pull a securitization or what have you because market conditions are volatile, and we get that, right? But what -- in one of those situations, what happens? Because like you -- it seems like you knew where the loan was going, but then you have to pull it. So does that result in like any -- what is the impact or something like that?

Sure. Yes. So for the most part, here and thanks for the question. For the most part, when we're choosing to launch a securitization, we're typically pulling loans out of a warehouse and then [indiscernible] them to that new securitization trust, right? So that's one of the reasons why we don't do a securitization every week, right? We need to sort of pool the right type of assets for our various ABS shelves to make sure that we have critical mass to sort of get to the minimum required deal size. And so sometimes, we will build a bit of extra capacity if we have an ABS deal on the horizon, we'll build a bit of extra or sorry, capacity is not the right word, but we'll hold some more loans on-balance sheet warehouses as we're preparing to move those loans into an ABS deal.

Right. So I guess, like the question is just when you make the origination, you have a good idea that eventually this loan is going to end up in a securitization versus this is going forward to a partner. This is going on balance sheet. Is that the right way to think about it?

That's right. Yes. I mean if you think about our various ABS shelves, right, we have the A, B and C deals, which tend to be primarily interest-bearing, but also have a little bit of split pay in a small amount of 0% loans as well. And then we have the longer-dated off-balance sheet securitizations our Z and X deals, which are both longer-term interest-bearing and then longer-term 0% offerings. And so we typically have some loans sitting in warehouses for each of those loan types. And so if we know -- like I said, that deals on the horizon, we'll go a little bit more balance sheet heavy leading up to the deals. And then in the event that a deal is pulled, which did happen last calendar year, we typically keep ample capacity in the warehouse is such that it doesn't put any undue stress on the warehouses themselves.

Great. Thank you for the question here. We received a question the question-and-answer box [indiscernible] asks could you help us get a better sense of the non-GAAP tech and data analytics spend that is headcount versus non-headcount related? And also to what extent -- I believe the question I was asking, what extent are those 2 sources correlated to GMV?

I don't have the exact split of the dollars that are head count versus the dollars that are non headcount. I don't have that in hand, apologies. But I would say of our 3 expense line items, tech and data analytics is the line item that has the most nonheadcount spend in it, at least in recent history. And so there is -- there are things like our cloud services infrastructure, which is variable with GMV and with applications and some other sort of infrastructure and data costs that sit in there, too, that tend to be more variable than fixed.

Let's go for a live question now. I think we have David from Wedbush. Go ahead and unmute yourself David.

Not sure if you're answering questions such as this, but curious about the gain on sale of margin, looking on Slide 14. It looks like it's been coming down over the past few quarters. Can you talk about how we should think about gain on sale margin pressure going forward? And I guess, timely with the Fed announcement today, it looks like there could be 2 more hikes in the [dot plot]. Could you talk about any potential pressure you could see on the gain on sale margin from that?

Yes. We received a similar question earlier. I would say that the repricing efforts that we're doing on the consumer side to move the APR cap from 30% to 36% should help us get more economic content into the loans that we're selling, and that should help us either maintain or, in some cases, increase the gain on sale pricing that we're receiving from third-party loan buyers. At the end of the day, our loan buying partners are solving for a yield on their side. And so if there's more economic content in the loans via higher interest that allows us to sort of keep a bit more and sort of increase or maintain the gain on sale pricing. So that's another area where the repricing work that we're doing should show up. There should be a benefit there as well as obviously showing up for the retained loans in terms of more interest income flowing through the P&L as well. In terms of the rate environment, I think obviously, the reference rates and that's one input on the loan buyer side. I think they're also looking at things like credit losses. And so as we've been running with reduced credit losses, that helps our loan buyers make their yields. And so by managing credit effectively and I think there is some, obviously, correlation or inverse correlation between interest rates and unemployment and in turn, credit performance. So if we're able to continue to manage credit, the ways that we have historically, that will also help us maintain our loan pricing or even potentially improve it given the last couple of quarters' results.

We received a few more questions in the Q&A box. So the first one is from Matthew O'Neill [indiscernible] Partners with the merchant repricing, how can we effectively model the impact of the progression of interest-bearing volume on the 36% APR path? Are there any other components to the initiative that will provide a material impact?

Hopefully, I'm tracking the question. I think the question is basically when will we start to see the benefit of the consumer interest changes that will occur as we move the APR rate cap from 30% to 36%. We -- I would encourage you to look at the table that we included in our last shareholder letter. I think it will take a bit longer for the loan book to fully reflect the higher rate caps. We showed a table with sort of 2 lines. One is the percentage of originations that are running under the new 36% cap. Obviously, that's the part of the business that's going to see the increase first. But it's going to take a while for those new originations that we're doing to be -- to show up fully in the back book or the platform portfolio. And so eventually, those 2 lines will converge. But it will take -- we've got a weighted average life of roughly 5 months. So it will take a while for the impact to show up. And then we're also -- we also have a ways to go in terms of getting the majority of the remainder of our interest-bearing portfolio up to that 36% cap, we were at about half as of the end of the March quarter. So some more work to do on that front as well.

We also received another question again via the Q&A box. Actually, the 2 questions. I think they're mostly related. So [indiscernible] tend to ask, do you anticipate there to be a margin uplift once rates start to go down next year or after? And related to that, would you expect the APR to adjust down soon after that? I think presumably, meaning consumer APRs will those also begin to adjust downward as a result of a lower interest rate environment or where they stay elevated?

Yes. So I'm going to politely decline to answer the first one. I just -- I don't want to get into guidance beyond the end of fiscal '23. But in terms of sort of the elasticity of the APRs in the context of the macro rate environment. We are trying to establish the new APR caps at 36%, really as a cap. And so it should be at affirm's discretion to reduce rates to the consumer if we deem that appropriate. I think it's going to be a function of where rates are, but it's not something that we would expect mechanically our consumer APRs to step down if rates were to start to decline.

Great. And thank you for the questions. It looks like we've reached all the questions and unless there's any last minute no one is raising their hand or the Q&A box. So with that being said, thank you all again for joining us today. If you have any feedback or questions, we certainly welcome it. This presentation will -- is already available on our website. A replay of this session will also be available on our website shortly. And of course, we're always here if you need our help. So can we just [email protected]. Thanks again for your [indiscernible] today. And we hope to see you again soon in August when we report earnings. Have a good day.

Thanks, everyone.