Klarna Group plc (KLAR) Earnings Call Transcript & Summary

Great. You talked a little bit about the GMV split between Pay in full, Pay Later and Fair Financing. I thought the quarterly results were really strong. So it was a little bit of a surprise to see the stock fall the way it did. And one of the concerns or at least the headlines that came out were some of the Fair Financing and how the provisions are taken upfront. So maybe you can walk us through the model as you've increased in Fair Financing, what that does to the transaction margin dollars and the provision for credit losses that happened during the quarter? And then what's the catch-up period look like as we go into fourth and into 2026?

Yes. So look, this was a very much unexpected approach, right? And I think we flagged kind of the dynamics of this at the IPO as well, right? Reality is like we have been building and we want to be an everyday spending partner, which means we need to be relevant in every single category, right? And Fair Financing, there is a category that's significant around that, right? And we have always been doing Fair Financing over the last 10, 15 years, right, and been building that portfolio, both in the U.S. and elsewhere, right? I think what we've done is, as said, we can accelerate that, and we have been accelerating that very successfully. In the U.S., grew at 244%. Globally, we grew 139% there. So obviously outpacing the market, but also outpacing our own -- our other products from a share perspective, right? And so the dynamics around this is really, in my mind, appreciating that it's slightly complex, but it is quite simply the fact that you invest upfront by taking your provisions upfront being prudent, which is in accordance with accounting guidelines, right? So if I take a simple consumer here, right, you would basically book all of your potential for that consumer to not repay you, but you would recognize the revenue over the time that the consumer actually pays you back, right? So on a 6-month loan, obviously, that is a -- over that 6 months, you then have a compounding effect as you grow your revenues while you upfront take your provisions. And that's what's happening here. We're growing our portfolio. And as we grow our portfolio in the beginning, it takes time to build up that compounding revenue effect, right, and particularly at the speed that we've grown it. So we were very well expecting, and it was a known factor that we would be in the third quarter having more provisions, right? And then the revenue from those cohorts of volume are accelerating, right? So interest income grew about 48%, while volume grew 139%. And so what we expect now is through the fourth quarter, and we've guided towards that, that we'll see a transaction margin uplift in the fourth quarter as we continue to expand Fair Financing, but the prior cohort volume is actually starting to then recognize more and more of that revenue through the fourth quarter. So that's really the baseline that we see here. I think I'm also really happy because we are expanding and we are well aware of that. And as we do that, launching the forward flow with Elliott is really a great way for us to find a really solid long-term partner that can support us and be able to continue to expand the growth of our Fair Financing product with the demand that we're seeing for this product, particularly in the U.S. but also globally.

Got it. And so maybe you can just specifically talk about the provisions for credit losses in the quarter. You did definitely telegraph to all the analysts that this was going to happen. But maybe you can just talk specifically on that number. I assume the majority of that was due to the provisions that we're talking about from Fair Financing.

Yes, exactly. So if you look at it, and I tried to illustrate this a bit in the earnings call, right, you can find that on the investor website as well. But ultimately, if you just took the realized losses, these are losses that are not related to the provisions. So these are the true actual losses. They actually went down a bit as a percentage of volume from 45 bps to 44 bps, right? So when you look at it in totality, right, and you look at the P&L, excluding upfront provisions, you actually saw a 25% uplift in transaction margin dollars excluding upfront provisions. And then the primary driver of the $91 million of provisions is the Fair Financing acceleration, which was very well planned and known and understood, right? And so that is really what takes you down to the transaction margin dollars of $281 million. So it is really that, that is the main driver here. And the accelerating growth is what then is going to kind of lift that in the fourth quarter. So that is really when we compound all of the revenue from the volume that we have booked through the last few quarters and they start growing, which they will in the fourth quarter, then that's where we see that uplift in guidance to $390 million to $400 million of transaction margin dollars in the fourth quarter.

So when you see the increase in the margin, the catch-up in the fourth quarter that you described, how come we don't see an incremental impact from the new Fair Financing deals? Or if you -- what about if volume explodes even further in Fair Financing? And why doesn't that dampen the margin in the fourth quarter?

Look, I mean, we obviously have that in the plan that we continue to expand and grow, right? It's a question about how much of your prior revenue is being then recognized or your prior cohort or revenue from your prior cohorts being recognized into the fourth quarter. So I'll make it very simple, and this is a very illustrative example. Let's for argument's sake, you say that you booked $1 billion worth of revenue -- sorry, $1 billion worth of volume. And over the life of those loans, you will recognize $100 million. right? But in the first quarter, when you've actually booked that volume, you will generate around -- you will recognize about $40 million of that $100 million of revenue, but you recognize 100% of your potential provisions, right, of, say, $30 million. So that first quarter, it will look like you've made a net of $10 million, the $40 million less the $30 million, right? But that means that you have $60 million of revenue left that you will be recognizing over the following quarters. And as those cohorts that we've been building compound, that number then starts outweighing even the growth of the portfolio, right? And so that is what actually happens, right? You've seen this in every single type of lending where you start in this process and then you start building that portfolio over time. So hopefully, that explains it better, Bryan.

No, that's helpful. I always find those illustrative examples helpful. Can you talk about the impact of the model now from the offloading of using the forward flow agreement starting the quarter?

Yes. So I think this is an important aspect of it, right, because we want to continue to expand, but we want to be doing so in a capital-light and efficient way to minimize dilution to shareholders as we continue to expand and take more market share. So the forward flow allows us to do that in the sense that what you're actually doing is you're pulling forward some of the revenue by selling these loans on a daily basis, right? And so the intent is really that this allows us to give another avenue for us to be able to expand. And what happens is, ultimately, your revenue will increase. You will then have no provisions for those loans. And over time, you can then expand and compound like that. And that's a very standard approach that non-banks do when they finance these types of loans in the U.S.

Okay. Great. And so how do transaction margins trend? We know the fourth quarter of the guidance. As we go into next year, is there even a bigger catch-up for Klarna in transaction margin?

So we're not going into kind of the forward guidance in 2026 until we finish 2025. But generally speaking, what I'd say is, look, we run -- the growth levels that we're seeing on an annual basis, both on volume will, over time, also align themselves with transaction margins. And what I mean by that is this is that as you mature your portfolio, you're going to see an acceleration in transaction margin. And then transaction margin dollars when you get to a certain level of maturity over multi-quarters, right, you'll see a similar trend in volumes, revenue and transaction margin just because you start getting that kind of holistic portfolio. But given the growth that we have, we have the capability to continue to kind of drive and mature this portfolio with a lot of growth potential.

Got it. And just the last one, you touched on it, but just delinquencies overall, it sounded like delinquencies actually trended down a little bit for you in the quarter. What do you see as the outlook there?

Yes. So look, I mean, that is the forward-looking indicator that we look at on a daily basis, on a weekly basis, we sit down and we, as a management team, looking at those things. I think the key thing for us is to -- the trends are looking well. I think it's important that we continue to monitor those trends, right? And we do, do that. It's part and parcel of what we've been doing for the last 20 years. As you all know, we've been around for 20 years, and we understand how to underwrite these things. I think the key thing is to keep that forward-looking track. Right now, trends are progressing in line with our expectations. And I think we are -- we just need to continue to stay focused on ensuring that, that is -- that, that works, right?

Got it. Sebastian has been very positive about the developments of Gen AI and the impact it has had on the company. Maybe you can just talk about what you guys have done with AI and some of the benefits you guys have seen.

Yes. So I think you've seen the customer service, example, where we've really leveraged it to drive productivity and efficiency for our teams by allowing the AI assistant to do more and more. I think yesterday, we talked about about 150 people's worth of work -- or sorry, 850 people's worth of work that we are managing through the AI assistant at this point in time, so continuous improvement there. But it really infuses everything in what we do, right? My teams, everybody is really, really working hard to leverage AI in everyday work, right, to just reduce the amount of kind of manual labor, ensuring that we can do analysis quicker, getting quicker answers on things, et cetera, understanding our systems better and ensuring that we can kind of drive that efficiency. So from our perspective, it's really infused in everything that we do. From my perspective, I'm always excited about this because reality is, I see so much that my teams can do today that they would not have been able to do before at a much more faster speed, whether that would be writing commentary, looking at better analysis and understanding really detailed level understanding of some of the things that we do within the business. It's just so much easier when our analysts are able to leverage the technology that we have and to be able to give that -- layer that technology on top of our own to really get better and better and better analytics that leads to better decision-making overall, I think.

Yes. And with that, maybe you could just talk about OpEx and what you guys are thinking the expense growth should be in the model?

So look, I mean, from our perspective, it's all about cost discipline. This quarter, we reduced slightly the amount of revenue growth versus -- sorry, slightly the amount of OpEx growth versus revenue growth, and we're going to continue to kind of work on ensuring that we have a tight discipline overall, right? And I think that's key for us. We are -- we are a seasonal business, obviously. So where we work very closely with our merchants and with campaigns and such through various parts of the season. But ultimately, it's all about managing and maintaining that cost discipline that we've been maintaining over the last -- since 2022. We had a chart in there that said we had grown revenues over 108%, while we've grown our cost base by about 2% in the last 3 years, which just tells you kind of the focus of the organization on ensuring that we'll continue to manage costs with discipline.

Niclas, can you talk a little bit about the deposit base funding options for Klarna, how that might impact the model if you look at bundling, balance, ACH?

Definitely. So we've got about $14 billion worth of deposits, which is our primary funding structure. Primarily, that's savings accounts. So that's a very strong cost-efficient way to fund ourselves. And I think it has been proven we've been doing this since 2013 as a very, very robust model. We do always want to have every tool in our toolkit, so hence, the deal with Elliott and others. But I think the -- from a perspective of ACH and balance, this comes back to that kind of being an everyday spending partner, right? If we now see people start using the card more frequently as an everyday spending tool, we have the balance connected to that. And that balance is now you're able to send your refunds, your cash back to that balance, consumers can then use that, right? And so what you're doing is you're bringing more and more of consumer spend into the ecosystem. And much like other financial companies, you then have the ability to fund yourself through the larger base of deposits over time, right? So I think that's a key thing. I also do think that processing and servicing fees, particularly in the U.S., which is one of the drivers why you see that number increasing is really about more of our volume being in the U.S. But ultimately, we're very laser-focused on figuring out how can we continue to reduce processing and servicing fees. And I think the card and the balance is part of that, because consumers will then more frequently connect us to ACH, et cetera, right, which will then help us to drive down some of those costs, right? Overarchingly, we're actually seeing in the U.S. a slight reduction in our processing and servicing fees, but they are just a larger part of the mix right now, which is kind of why we want to continue to focus on processing and servicing. I think bundling is very important. We're starting to see some traction on that. It's something that we need to continue to do. So we are very laser-focused on ensuring that we find new and innovative ways to leverage our ecosystem to drive lower costs, which then ultimately allows us to serve our consumers and partners better.

We only have a few minutes left, but I wanted to touch on some of the other revenue streams when you think about Klarna, how you guys drive commerce transactions there and advertising. Can you just touch on those?

Sure. I think it's a really key point. And we talked about this before in the prospectus and a bit around IPO, but maybe just taking a step back, right? We obviously collect SKU level data for purposes of underwriting. We've been doing so for 20 years. And for many years now, we've started figuring out ways to leverage this understanding subject to consumers' consent, et cetera to help them find better deals, help them find better ways to save money, save time, have more control of their finances, right? And what we've seen is a growth in our shopping app, particularly in the U.S. with stands for around about 30% -- 30%, 40% of our volume, where consumers start their shopping journey on the Klarna app, right? And that obviously gives us the opportunity to be able to earn some affiliate revenue on that, et cetera, as consumers find what they're looking for, best deals and so on and so forth, right? So that's something we want to continue to develop, obviously. I think it's a differentiator again for how Klarna thinks about how we create value for the consumer and how we find ways for them -- for us to support them in their everyday lives. So that's really a key focus for us as well, right?

Niclas, I forget how many years you've been with Klarna, but maybe just as one of the things to wrap on, just how do you feel like the business is trending from when you started to now?

So look, I joined in March 2021. So I think everybody remembers March 2021, right? And then, since then, I think ultimately, I think we have just gone from strength to strength. And what I mean by that is, I think, we're a better operating system now. We have a very strong focus on customer obsession on efficiency drive. But we're also, I think, very clear about the building blocks today of what we're trying to build, right, which is really being that everyday spending partner, being that neobank. Sebastian talked about our objectives yesterday. But it really, to me, comes down to our focus on our partnerships with PSPs, Apple Pay, Google, Stripe Link, JPMorgan, Worldpay, you name them, right, right, getting that default and being more ubiquitous there. At the same time, working with large partners, ensuring that we help them expand globally, ensuring that we give their consumers the best product features possible, right? Getting the card in every wallet, I think, is a key element of this, being able to expand and being ubiquitous because I do really believe that if you take those elements, couple that with having a full suite of our product set across all of our merchants and at the same time, then leveraging some of the capabilities that we have around our bank account and such, right, I think we have truly got the ability to be that everyday spending partner and the next kind of large global neobank. So I think it's been really interesting, and I think we're just going from strength to strength when it comes to that.

Last question I'll ask you is just on any kind of medium-term targets for Klarna and some of those key drivers, I guess, we've talked about today. But how do you see kind of setting up the medium term?

Yes. Look, in the medium-term view, we have been relatively consistently, right, over the last 20 years, compounding growth, right? And particularly over the last few years, we've been growing at those 25% to 30% annually. And I think that is something that I would want to see us, and I see no reason why we can't continue to compound in that way for foreseeable future, given those building blocks that I just spoke about and we spent some time on, Bryan.

Well, thanks so much for doing this virtually. That was very helpful, and we look forward to seeing you in person. But thanks so much, Niclas.

Thank you so much, Bryan. And sorry, I couldn't be there in person. I'll be there next time.

Yes. Thank you.

Take care.