Katapult Holdings, Inc. (KPLT) Earnings Call Transcript & Summary

Hi, everybody. Thanks so much for joining us again today, and welcome to our last session of today. We're delighted to have from Katapult, Orlando Zayas, the CEO; and Karissa Cupito, CFO. So welcome, Orlando and Karissa. Thank you so much.

Could we perhaps start just with a high-level overview for any investors who may be unfamiliar with the business?

Sure, Ben. I'll start. Thanks for having us. I appreciate the time. Katapult, we provide lease-to-own options for consumers, both online and in-store, for those who have had difficulty finding finance options to purchase the durable goods like appliances, furniture, electronics and tires, they need for everyday living. Our technology solutions get these customers through a purchase decision quickly and efficiently. We are a customer service-first -- customer-first organization, providing clarity and transparency through the transaction process and after acquiring the goods. We focus on financial inclusion, bringing these customers left behind by other financing sources or options and a clear choice.

Well, great. So maybe diving in, you touched on this a little bit, but maybe talk a little bit about who your target customer is. I think as investors have kind of seen like the buy now, pay later wave, they're starting to get more familiar with, okay, I understand what these kinds of products are and maybe I might test it out myself. Who is your target customer? And perhaps what are the financial services they might be using today? And you're perhaps coming in replacing that or additive on top?

Sure, Ben. It's really all the customers that have been turned down for traditional financing, those with little or no credit or may have an issue with their credit score in the past. These are the customers that have little choice, using a private label credit card or split for 4 transactions that many of the BNPLs offer. They may be maxed out on their credit cards or have few options to acquire these essential items. These are the folks that are either buying used, substandard equipment or just doing without. And so we provide them an avenue to get the things that they need. If your refrigerator breaks down, you don't have a lot of choice, you've got to get that refrigerator today. And if you're one of the customers that I've described, we're definitely a good solution for them.

Very helpful. Maybe a more kind of tactical question. I think businesses like yours that service perhaps those lower credit quality customers tend to be kind of countercyclical. And there's just kind of so many factors going right now in the macro environment. There's inflation, rising rates, tightening credit, a tight labor market. We're kind of rolling off of COVID, where we've got kind of the ebbs and flows in e-commerce, supply chain disruptions. Kind of a pretty broad question, but can you kind of talk about how all those factors are kind of impacting the business? Probably some are tailwinds, some are headwinds.

Sure. Sure. There's a lot to unpack here. So let me start with inflation and the tightening credit. Our customers are a little bit more sensitive to inflationary pressures, like rising gas prices, food. But unfortunately, it doesn't slow down demand for appliances and furniture and electronics. Obviously, COVID, the COVID impact over the last couple of years has changed buying behavior as the customers went from buying these essential goods for the home and are now doing more outside activities like sporting events and travel. And then if you couple that with the supply chain issues that are occurring worldwide, it's been a challenge. We expect these conditions to continue and start affecting prime consumers as well during the end of the year. And this is where our business goes to the countercyclical part. If you look historically you'll see that during times of economic distress, prime lenders will typically tighten up, sometimes pretty dramatically. In this situation, since we are highly dependent on waterfalls from prime lenders, we see better customers who have traditionally been approved for prime lending now declined and they flow to us. So for example, back in the beginning of COVID, when the prime lenders feared a major recession, they all tightened up really dramatically. We actually saw the best vintages during the lockdown periods and until the prime lenders started to loosen.

Interesting. So it definitely makes a lot of sense. Maybe kind of on the COVID angle. So we've seen e-commerce ebb and flow and kind of the supply chain. Is that more of a headwind? Or is that starting to -- have your kind of merchant partners sorted out those issues? Are things starting to pick back up there?

Yes. Obviously, they're still working through the supply chain issues, which are the big thing. But I think demand is somewhat softened from during COVID times, especially for these appliance and furniture retailers. We see it starting to go back to normal or what I would call pre-COVID levels. I don't know if there ever is going to be a normal again, it seems like. But we continue to be diligent around the credit portfolio and be real surgical around tightening and provide the best approval rates for our retailers, but also maintain our per lease profitability. And we see that in the results that we're seeing from a per lease perspective, and Karissa can talk a little bit about that more, but the retailers are struggling. I mean -- and that's my best customer is when they're struggling to add new customers, they're looking for alternatives to drive incremental sales, and that's really our best customer and then the best retailer that we could find is the retailer that's looking for additional volume.

Great. So maybe, Karissa, on kind of the underwriting Orlando was talking about, and I think you guys talked about this in your most recent earnings call, you're kind of tightening as the macro environment kind of continues to evolve. Can you maybe speak to that a little bit? Are you seeing any kind of leading indicators in terms of credit quality, missed payments? Is it sort of preventative based on what you kind of anticipate, if you could kind of give us some color there?

Sure. So we started seeing signs of credit normalization actually at the end of Q3. And so starting in Q4 of 2021, we did an underwriting tightening to proactively start managing our portfolio and then continue to do tightening, very targeted tightening in Q1 of 2022. So we believe we've stabilized the portfolio. I think what the tightening we're doing, we're starting to see obviously improved delinquencies in the portfolio stabilizing. And now we're really focused on, okay, we've tightened and now we are monitoring the portfolio and really looking for ways to find different pockets of the portfolio that we can actually help increase approval rates, which helps our retailers, right? So I think it's something, like Orlando said, we had record performance during the beginning of COVID, where we were seeing really strong performance and lowest delinquencies in the history of the company. So now we've really focused on being prudent in our portfolio risk management in anticipation that prime will have to eventually tighten again and we'll be there with a really strong balance sheet to fund it.

That makes sense. Maybe kind of sticking with that theme a little bit. Again, understanding that your business is a little bit different from the traditional or the sort of maybe perhaps better known as buy now, pay later players. In that space, we're seeing some kind of headwinds to loan volume growth as rates are kind of rising. And there's been a lot of headlines around companies having trouble or not having as much success as they would like securitizing. Can you perhaps explain a little bit, are you seeing any impacts from this? And perhaps for investors who are, again, unfamiliar with the model, how is -- how are your leases financed? And how are they perhaps different from some of your public peers in the space?

Yes. We are funded differently than some of the BNPL players in the space because we actually utilize an asset-backed facility. So we have an asset-backed facility with a commitment of $125 million that we can draw on, and it's based on originations. So as we originate leases, we pledge them to an asset-backed facility and we get a 90% advance rate. So at the end of Q1, we had $76 million of unused capacity on that facility. So from an ability to continue to grow and have the capital to do so, we have that locked in with our current facility. And so the only thing that rates may impact for us would be our cost of capital. Right now, we have a LIBOR spread, but our floor is 2%. So LIBOR would have to grow in excess of 2% for it to really impact our income statement at all. Because of that floor, we're already paying at 2%.

Okay. Great. Maybe switching directions now. Maybe can we talk about the sales side? Can you talk a little bit about your kind of your pipeline of merchant partners? And I think in the most recent quarter, you called out 27 new merchants. Are you kind of seeing any common characteristics across verticals or sizes? Or is it more broad-based? I guess, the question both in the most recent group of onboarded merchants and kind of your pipeline?

Sure. The pipeline continues to grow. We're seeing merchants across the board from different industries starting to adapt to lease-to-own. I've been in this business since 2013. And 5 years ago, 6 years ago, they wouldn't even talk to you. And I think now they're seeing that, one, lease-to-own is a good option. I think they also like the fact that we're very clear and transparent with the consumer, and we are customer-first, and that we -- that reflects in our NPS score. So when I look at the merchants that we've added recently, they are pretty much across the board, although we are seeing a lot of good on the auto side. And I think that's probably related to the fact that used cars are so expensive, they're hard to get. People are holding on to their cars longer. Well, I know a few years ago, average car ownership was 11 years, which is still amazing to me. It's probably longer now. And if you keep a car that long, you've got to replace the tires. And if you need the car to go back and forth to work, you got to keep that car in tip-top shape. So we're seeing some real good adoption on the auto side, specifically tires. And then the furniture side and appliances are growing fine. Again, it's more -- many of these merchants were -- they were brick-and-mortar focused before. When COVID happened, they had to shift their tactics going online. And I think what they recognize with us, which I think leads to the pipeline continuing to grow, is that we treat the customer right, we do the integration quickly, we do the transaction very quickly. And as you know, whenever you've abandoned a cart, if the minute you've abandoned a cart, you start getting e-mails and text messages from that retailer. They recognize that, that customer has got -- we've got to close the customer when you have them on the website. So we help them with that. And we do it in a very efficient, very clear, very transparent way to get that customer through the purchase decision quickly and easily and getting them to come back. And Karissa will talk about our repeat business, but our repeat business continues to be strong, and that's because customers are happy with what they've done in the transaction, and they come back over and over again to lease again from us.

Great. So I would love to come back to the repeat business, but maybe just another question on the merchant pipeline because it seems like you've had kind of some success recently with continually onboarding more and more merchants. Can you talk a little bit about how merchants mature as they onboard? So once they're sort of up and running with Katapult, how long does it take them to kind of get to the expected run rate in terms of volume? And then is it kind of growth from there? I'm sure -- surely there are some ebbs and flows with the credit cycle or whatever else there may be. But what does that kind of normally look like when you kind of onboard a new cohort of merchants?

Sure. It takes a little bit of time. Typically, we'll get a merchant through one of a couple of ways. They either come to us through a waterfall with the prime lender-elect firm, or they come to us, they want to insert us into their checkout. And we like both. We want the merchant to see that, one, if they have a prime solution and they're declined, you want to capture that consumer. So make them an offer. And so that's one. And we have many retailers that all they do right now is the waterfall. But really, where it works for the retailer is to have both. So you're capturing those people that get declined. You're capturing the direct -- some -- we call them self-identifiers, the people that say, "Hey, I've had issues with my credit. I know I'm not going to get approved for the prime lender. I want a solution." And so what happens is that usually happens in stages. They'll do an integration first maybe on the waterfall. They'll do an integration on the direct. And then once those are done, we have -- and we have -- and then also, if they have brick-and-mortar stores, we have also an in-store solution where they can capture those consumers in store. And so we really have kind of 3 ways to onboard a merchant, the peak being to get all 3 done. And then once -- and so that will take anywhere between 6 months and a year depending on their integration capabilities. And then once they're up and running, we work with them to target this consumer. The best example I have with that, and I've talked about it in the past, is our partnership with Lenovo. And when we first started with Lenovo, they were skeptical. They thought this consumer was not shopping on their site, that it was people like you and me who have a Lenovo at work and want to buy one for home or for their kids to go to college. And what they found is that, no, this customer was shopping on their site. And so we teach the retailers over time, to focus on this consumer, to do targeted marketing campaigns. Obviously, we do targeted marketing campaigns to our existing customers or people that abandoned the cart. Or maybe people teach them how to target this customer to get them into the flow. So that is an evolution. And I think you get to a point in a year and then you really start fine-tuning what the marketing messages are, how they advertise it on their site, how they capture this consumer, and that really gets to the ultimate, which is, again, about a year. It just depends on the retailer.

Great. Maybe kind of switching gears again. Can you maybe talk a little bit about the current investment cycle? I think you guys have talked about hiring sales forces, you're making some kind of tech investments. What are the top priorities here? And kind of what should we expect in the P&L over the next, say, 12 to 18 months as you kind of go through this cycle?

Yes. So we began investing in the second half of last year. So we've done a lot since then in terms of initiatives and priorities, really focused on enabling growth and taking advantage of this large addressable market. So our focus have been in sales, marketing, product and tech. Starting with -- we've added several strategic roles throughout the leadership team, Chief Marketing Officer, Vice President of Strategy and Corporate Development, Vice President of Strategic Partnerships, Vice President of Sales, and then a Chief People Officer. And so one of our last remaining strategic roles left to hire is the Chief Revenue Officer. So we've made really good progress on that side and attracting great talent who is really adding to our growth plans and initiatives. From a sales perspective, we have doubled the sales team from where we were a year ago. So now we have a lot more people selling our product, similar to the hires that we did there were business development managers. So really focused on that. And that's why we're seeing some of that merchant acceleration and launches throughout the quarter. And then lastly, products and technology. So we're working on product enhancements, incremental technical capabilities. Lots of different things that will differentiate us from an integration standpoint with our merchants. So how do we get more merchants to say yes and how do we make it easier for them to integrate with us, and then also consumer-facing different enhancements and capabilities from that perspective. So looking forward to announcing and launching some of those new enhancements later this year.

Great. And what about pricing? I know in the past, you've talked about experimenting with the pricing on your origination fees. Is that still an ongoing initiative? And what sort of kind of impact are you seeing on customer acquisition, checkout conversion? And how does this kind of fit into your gross profit margin profile?

Yes, great question. So we did start testing and actually built an entire testing environment with AV control tests for lots of different pricing. So we've been experimenting with different retailers, categories, et cetera, on various different pricing terms. So what we found -- what we were able to find because we have been able to build a sophisticated AV modeling test is that these pricing initiatives do drive conversion rates. So we are seeing higher checkout conversions across the board. But what we're waiting to find out, because it just takes longer for the results to come in, is how this impacts our gross profit. So if we're charging a lower origination fee, ultimately, does that result in a lower profit margin? Or are we actually attracting a better consumer so our profit margins are actually staying the same, if not higher. So we're kind of -- we're still in that monitoring cycle of where we think our gross profit is going to be for these types of initiatives in these pricing terms. So I wouldn't say we've rolled it out across the board yet. It's really still in testing mode, but the initial results are very positive. So we're looking forward to rolling that on a larger scale if we see the results we want to see in the gross profit margin.

And then if I can add, this testing revolves around the conversion rate. Obviously, since we are heavily dependent on the waterfall, which is great and good, sometimes it is that if that customer applied for financing with a prime lender and they were turned down, maybe pricing is going to move the needle to get them to acquire the good through us. And so we're really testing various -- very precisely on what turns the knob on conversion rates and how do we improve conversion rates. Is this ultimately what wins for the retailer, what wins for us, but we want to see what that profitability looks like long term.

Great. And Karissa, if I could just ask a technical question, I think it's helpful for investors. As we've seen over the last like 2 or 3 years, focus has really shifted from EPS EBITDA to kind of gross profit. Can you just give like your calculation or the way it's [ viewed ] just a little bit different maybe to other kind of payment [ themes ] that investors look at? Can you just give like a very brief explanation of what your gross profit is and how it's calculated?

Yes.

We lost your camera.

Sorry, just -- I will talk. I don't know what happened to my camera. Can you hear me at least? There we go.

There we go.

Yes. So gross profit, so the way that we define gross profit on the P&L is essentially, since for a lease product, all of the cash we collect from the consumer on a lease payment basis goes through our revenue line. So we're essentially -- especially now after we adopted a new accounting standard, ASC 842, we're essentially cash basis. So all the money we're collecting goes and runs through our revenue line. And then we actually [ have ] origination, we buy the item that's being leased. So whether that be a sofa from Wayfair, a computer from Lenovo, we're buying that from the merchant. And so that cost basis is our cost of revenue. So really, the margin that you calculate is the cash we collect from the consumer over the price of the item that we purchase from the merchant to get us the gross profit that we're talking about.

Very helpful. Okay. Maybe another question kind of on the investment side here. Can you kind of talk about your broader consumer awareness marketing? Orlando, you indicated earlier, some customers kind of self-identify. But in general, how are customers discovering you? Are they kind of passing down through the waterfall? Did they kind of see you as an upfront presentment when they're shopping? Are they kind of already aware? How do you think about that?

It really depends on the retailer. At many retailers, they don't see us until they get declined by the prime lender. And so they apply for financing, if you know approval rates can be anywhere between 50% and 60%. So the rest of the customers will come down to us immediately. We return, hopefully, an approval back to them. And that's where it's important for us to lay out exactly what this product is to the consumer because they may have been intent on doing an installment loan. And now they've got a lease-to-own, so they want to understand it and understand the differences. And so we're real clear and transparent about that. But then -- and other lenders, they'll have this finance page, for example, where they'll have all the different lenders that are available, so that the customer can make that decision on what financing needs that they have or where they think they might apply. Obviously, ours will be -- we'll talk about no credit required, but it also lay out the story on when they can get to ownership if that's what they desire, so that they're making a clear decision. I think that's probably the biggest difference between being online and being in the store is you don't have a salesperson that could have to explain it, you've got to be able to have that conversation or that communication directly with the consumer about what their options are, what it costs them and be fully transparent because they can quickly Google you and find out another solution or find out if this is real or not. So we've taken that approach upfront from the very beginning to be clear and transparent. I know I probably said that a hundred times already, but it's important to us. And that we try to approve every single customer. And so part of it is the waterfall, part of it's the direct, maybe a financing page, and then the other one might be -- we're just in the waterfall, like next to Afterpay and other BNPLs, but they see the no credit required option and they'll click into that and get more information about it.

Great. And earlier, you mentioned repeat users. So obviously, there are more and more customers becoming increasingly aware. I think you recently called out something like 49% of originations are coming from repeat customers. Where did that number come from? And where do you think it can go and sort of -- what kind of things are you doing to sort of drive incremental engagement with pre-existing customers?

Sure. That number has been around the 50% for, I'd say, the last 12 months. We got really great customers coming back to us after COVID or during COVID, I should say. And -- but some of those people now they qualify for prime because the prime lender has loosened up and so they're able to make their purchases with another installment product or something. But it really starts around our philosophy that seeing the good in people is good for business. And so we try to approve everyone, give them access to a higher line, communicate with them throughout their journey, let them know when they can get to ownership. Let them know what the best option for them at the time is. If they pay it off in 90 days, for example, they pay 5% or less. And we let them know that. We encourage them to do that because we know that customer will come back. And I think it's proven in our repeat rate. And I think that our repeat rate will continue to climb. But again, as I said earlier, the repeat rate is also subject to if they've now -- if the prime lender has loosened up and they apply for prime and they get prime, I'm happy with that because they graduated, if you will, to a prime offer, and I'm real happy to graduate that customers and move on.

Fair point. Maybe sort of on the same subject, your product pipeline. Is there -- obviously, you have a lot of focus on kind of growing the lease-to-own business. But is there -- is it fair to think that over time, perhaps you become a more holistic financial services provider to kind of that customer group? What does the path look like there? Or should we think about it as more kind of penetrating the existing online durables LTO market?

Yes, definitely, Ben. When we look at our customers and we look at the loyalty that we've developed with this consumer base, I think it's logical to say, are there other products? And we're -- the long-term strategic plan that we've laid out for the Board as well as on previous investment decks talks about how we're going to look for other products, whether it's small installment loans, maybe a secured credit card or a small balance credit card to help them through those difficult times. And since we have the credit data, we have the payment data on these customers, I think logically, it makes sense just really focus on those consumers that we have. We know the payment history. We know what they've bought. We've got a plethora of information around this consumer. So there's got to be -- there are definitely things on our strategic plan to look for other products that can help this customer maybe improve their credit, get to where they need to be and help them through this time.

Great. Maybe kind of a little bit of a change of topic. We've kind of talked about the waterfall several times. Can you maybe talk about that a little bit? How does it kind of work from a technical perspective? And on the merchant side, how does a merchant kind of go from either starting out as an Affirm partner and becoming a Katapult partner? Can you have multiple waterfall partners? Or is it exclusive with Affirm?

No. We actually have some relationships with other prime lenders. We're in waterfalls with other prime lenders. And so it's wide open. We pretty much have opened it up to any prime lender. We want their declines. We want the retailer to get us their declines. And so it either comes through -- there was a direct integration with Affirm where if it's an Affirm partnership, we -- their data goes from Affirm to us automatically. In some other relationships, it may be a third-party waterfall company that's routing the application to the prime lender, maybe a second look and then to us. And so it just depends on the retailer and what their appetite is. But that, to me, seems like the best way to get into a retailer, you're maximizing the approval rate for the consumer, you're bringing incremental sales, and then you open up the door to have those conversations about, put us on your website, do marketing, put us in your checkout so that these customers that are self-identifiers can come in. And that's kind of the evolution of the waterfall, but it usually starts with the waterfall. They see the benefit of approving more customers, getting more incremental sales and then they want to deepen the partnership.

Great. One of the other products, I think investors also know less about is your in-store product. Can you talk a little bit about that? I think investors kind of perceive you as being online lease-to-own. But of course, there is more to it than just that. Can you talk about that product a little bit?

Sure. So we've always had -- when I took over the business in 2017, we had an in-store product, not too much different than some of the other brick-and-mortar in-store solutions. But we are working on a better solution that will take the transaction and put it in the customers' hands on their phone so that when they go into a store, they're not having to give income information to a salesperson. The approval amount is sent directly to the customers, so they know what it is. Because when we look at online versus in-store, what you see is a person can get approved for $2,000, and maybe they wanted the $600 sofa, but there's a very good salesperson in the store that says, "Oh, you got approved for $2,000. Let's get you that dinette set. Let's get you that sofa to go along with that equipment." And then suddenly, that customer is walking out with $2,000 worth of stuff that maybe they didn't -- couldn't afford or didn't want to afford. And so we want to put the transaction back in the hands of the consumer. So the consumer is making that decision and there's a very light POS integration so that the salesperson literally hits a button, sends the application to the customer via their phone. They fill out the application. Once it's approved, we go back to the retailer again electronically. They send the card to us and we're able to process the transaction purely on the consumer's phone. And then we sent a note back to the retailer saying, it's approved, release the merchandise. And it just takes that element out from a compliance perspective, from a clarity and transparency perspective that the customer knows exactly what they're walking into, whether they're standing in a store or whether it's online.

Great. Switching gears again here, maybe something again, kind of tactical. What's your current line of sight to the holiday shopping season? We talked a little bit about the technical kind of work you're doing. I feel like I remember when we first met you guys, you were -- you were telling us the summer, it is not a break and just when everything is kind of getting ready for that all-important holiday season. So could you perhaps talk a little bit about where you are and sort of what your expectations are for this -- the end of the year?

I keep hoping for normal, but again, I don't know what normal is. I think we believe that the supply chain issues will more or less be resolved by the holiday season. And that, barring some other variants or other issues, that we should return back to normal shopping patterns this holiday season. I think there'll be more family get-togethers. People will start thinking about their home and if they're going to have a holiday and they need to replace that new -- the old sofa with a new one. So we're anticipating that the holiday season will be back somewhat to normal. The supply chain issues will be relieved. I guess the big question is, what will the prime lenders do? Will they start tightening up around that time because of the inflationary pressures, which, again, would be a boon to us? So we're actually very hopeful. The signs we're getting from the retailers that we're talking to is they start getting very aggressive around this time of the year because they realize they're going into code freezes and stuff in the fall. So if they're going to get our solution in, they've got to get it in before the end of October. And we're starting to see some of that coming through.

Great. Maybe perhaps 30 seconds left. Can you talk again, a high-level question about the competitive environment. It seems like you have great partnerships with companies that -- investors who know you not as well, may perceive as competitors. Where do you see yourself fitting in? And has the competitive environment changed at all in the last year or so as kind of things have moved online?

Yes. So when I think about the competitive landscape, there's a couple of things that go into that factor. One is there's the BNPLs that last year were the darlings, if you will, of the retailers because they had big platforms of people that would have some loyalty to them. And the retailers were interested in driving those consumers, obviously, to their sites, and it was a quick and easy transaction because they're all returning basically a card number. And so we're finding that, that's softened a little bit, I should say, that the BNPL has had their high time last year. Most of the big retailers have already integrated some sort of BNPL option. The regulation is getting a little stiff around it. Competition is getting stiff around it. And so I think what's going to -- what's happening now on the competitive side is that the retailers are now looking for another solution. And so when I look at the brick-and-mortar LTO, many of the competitors are still trying to figure out e-comm. And that's -- that was evidenced in the underwriting challenges some of them have admitted to earlier this year. But you can't just take an in-store solution and put it online. It's very different. Fraud is different. Purchasing behavior is different. And the customer isn't always swayed by the good salesperson to take advantage of the transaction without full knowledge. And so that's why we're inventing the in-store solution I talked about to put that transaction in the hands of the customer and trying to stay ahead of the brick-and-mortar competitors from a technology advantage, making it easy, making it clear, making it transparent. And we're going to look for retailers that are focused online. We'll have a brick-and-mortar solution for those ones that are omnichannel, but we really think that as consumers, which they feel really comfortable after last year, shopping online, we want to continue that growth with our retailers and help them get there.

Great. Well, I apologize, I kept you over a minute or 2 here. So unfortunately, we need to stop there. But thank you so much, Orlando and Karissa, for joining us. And to everyone watching in, thank you, and we look forward to seeing you tomorrow. And have a good night, everybody.

All right, Ben. Thank you.