Affirm Holdings, Inc. (NASDAQ:AFRM) Barclays 2022 Emerging Payments and Fintech Forum May 17, 2022 3:20 PM ET
Michael Linford – CFO
Conference Call Participants
Ramsey Clark El-Assal – Barclays
Ramsey Clark El-Assal
Welcome back, everybody, very pleased today to welcome Michael Linford, CFO of Affirm to the conference. Michael, thank you for joining us again. It’s great to have you here. Great to have you back.
Thanks for having me.
Q – Ramsey Clark El-Assal
Let’s start with a question that I often put at the end, but I’m going to move up to the beginning, which is sort of like the long-term vision of the company. When you — and I know this is one of these crystal ball things like knows. But when you think about 5 years out, 7 years out, what does the company look like? Is it still primarily a kind of a bio-related lender with sort of ancillary products? Or do you see the evolution from a product perspective into something that’s different than it is today? What do you think?
Yes. I mean, we always start with the mission when we answer this question because it’s both the most long-lived part of our identity. And it’s also a good indicator of where we think the business will go over time. And it’s pretty broad remit. Things that are in scope for Affirm are things that improve lives through honest financial products. And that is obviously a huge statement because that can mean anything with in financial product excellence as long as it has honesty and at the end of the day, it improves lives. And that’s really the scope for it.
We think of ourselves as a category leader in the part of that today, this thing we now call BNPL. And we’re certainly a category leader in fintech more broadly. And with the thing that we’ve started with is building a network. And I think for the next, I don’t know, a few years at least, everything we do is going to be focused on reinforcing both sides of the network.
On the consumer side, that means continuing to add new financial products, new points of engagement everything from shopping to crypto, the Super App, things we’ve talked a lot about and, of course, Debit Plus. On the merchant side, it’s continuing to add things that help their business better, so increase the efficiency of money through the conversion of sales, find new marketing service for them and even improve customer life cycle experiences by things like returns management. So all of these things in the near term are going to be focused there, but we don’t lose sight of our mission at any point in time here at Affirm and we aim pretty big.
Ramsey Clark El-Assal
Okay. You guys have signed some really massive deals, obviously, Shopify, Amazon. And as we saw in the quarter, I mean, the volume growth is really impressive. What inning are we in on those deals? How should we think about the life cycle of those deals, where are you in terms of the rollout, the penetration of the end-state opportunity?
Yes. I love this question because I really do feel like a big disconnect between Wall Street and operators of businesses is the immediacy of these things. And I want to remind people that we went to GA on Shopify in June of last year. We have even hit a year there. And the material part of the rollout Shopify happened when we got a bunch of folks into the system with the default on setting for Shop Pay and that happened in the latter part of our Q1 and into the first part of Q2.
And so I think about the time line really starting is like October for Shopify. So our most recently completed quarter was through March 31. So we’re talking about 5 months of life for a program that has years of scaling to do, Amazon’s similar and that we rush that thing out and got really proud to have gotten live on the days before Black Friday. But again, that was November. That was not very many months as well. And so if we’re using the baseball metaphor, I mean, I think this is the bottom of the first hitting. I think there’s a lot of time lap and that means that we have a lot of growth and scaling to do. We would estimate that for both Shopify and Amazon, there’s many turns of growth left to do in just getting to the share of cart that we’re supposed to get to. And how are we going to get there?
So some of it is about the optimizations that we need to do on those sites. For example, product display, page presentation of the offer, all the tunings and optimizations that we need to do. But then there’s the – the more, I’ll call it, discrete and step change improvements that we get out of rolling out more products on Shopify, we went live with our split-pay product. We’re really excited to have announced last week that we signed and renewed our deal for 3 years, and we’re now rolling out adaptive checkout. And we’ll also be rolling out higher AUV offerings in both interest-bearing and in long-term zeros. And that’s a really big step change it addresses the holding of merchants, a whole new set of transactions and for us, a big source of GMV growth.
And on Amazon, we talked a lot about being very early in us testing in around new products, and we’re going to keep doing that. And so we have both kind of smaller tactical optimizations and then big step changes. And then, of course, both of those 2 partners have a lot of ambitions besides their U.S. owned properties. There’s a lot of Shop Pay now that’s obviously a global business, so we want to participate in that, and we’re going to fight to earn that. And the same thing is true for Amazon is, of course, very big in level. And I feel like we talk too much about these 2 players sometimes because as big as they are, the best part about having these players is the benefit that they give to us on everything else. There’s no greater endorsement of what we do. And value to the other merchants in that scale network that we get for partnering with these guys. And so yes, we feel like there’s a lot of wood to chop here and we’re in the very, very early innings.
Ramsey Clark El-Assal
Okay. You mentioned sort of the new products at Shopify. And I think that’s also probably an underappreciated part of the story and the degree to which the product set evolves over time at these large merchants. Maybe comment on that a little bit. What have you seen in the past with larger partners that you have, whereas over time, you might start here, but you actually end up in a different place?
Yes. I think like everything in the world, time is accelerating here at Affirm. So the example I can give folks is really the ramp-up that we had with one of our largest partners, and that’s Walmart. And that was a deal that we signed, and I think 2018 is when we first signed it, and it was a huge endorses what we were doing at the time and still is and we’re very proud to have that partnership. But it did take us a solid 3 years really almost coming up on 4 years to really make that program what it is today, and it still has a lot of runway. I mean, speaking of, and we think there’s still plenty of runway to do there.
I think we’re able to move fast through with the other large players in part because I think the market overall has changed. And so in the early days with Walmart, we were — like with a lot of our merchants, we were trying to persuade them that the category was a thing that we need to pay attention to. If you wind the clock back to 2018 or 2019, no one had ever heard of this. And so we were working hard to persuade them. This was a thing that they need to do whereas I think today, it’s stipulated in most e-com environments that they need a strategy here. And I think that plus the fact that there’s just a lot of work to do. And the work — I think sometimes folks want there to be like a really short list of really big, obvious things that move the needle. And it’s just not the case. It is truly a thing where it’s a long list of very small things. We showed you everything we ship on a given week. We’re shipping code every few days, and I told you what we’re shipping, any one of those things, you’d probably not think is all that important, but it’s the sum of all of it. Max kind of made reference to this. And I think the culture of the ethos here at Affirm is very much one of constant improvement.
And yes, there are things that are set changes like new products, and there’s things that are set changes like new partners, but a lot of that work that we do is iterative. And in the case of Walmart, we really like what we’re able to do with them. Today, we like the cemented relationship that we have there, but it’s a byproduct of many years of very hard work.
Ramsey Clark El-Assal
Talk about the competitive landscape. I mean you guys are obviously winning out there. How do you see the competitive environment? Is it other BNPL providers? I mean, obviously, to some degree it is, but is it also credit cards? Is it — how do you think about the competitive landscape and where you guys are situated in it?
Yes, I think, it’s evolving. As I mentioned, I think 4 years ago, no one knew what the category was. I think over the past 1.5 years to 2 years, it’s become very mainstream and down the middle, but it’s also going through a period of maturation in terms of some of the less, I don’t know, less fun parts for some of these more competitors, which is there in about risk management right now. And the thing that’s different about the Affirm is that we started off with that. We started off in the I-O business. We started off in the space. We talked a lot about this over the past year. We did the hard thing first, right? We did the thing that risk management really mattered. And it’s true that risk management and the high AOV always mattered and it will matter in any environment.
It’s also true that in the lower AOV side, the risk net mattered less 1.5 years ago than it does today, and I think you’re seeing pretty real time some of our Split Pay paying for competitors really coming in terms with the conditions in the market right now. And that caused them to behave a little bit differently and that all accretes to us. We were able to grow and thrive in these times because others are just learning how to be more mature and responsible, and we’ve lease on that and that leveling of the playing field allows us to really score a lot of points right now.
I think the truth is, though it will continue to be competitive. There’s still a lot of market opportunity here. And notwithstanding the current equity market rotation, I think they’re still a lot of enterprise value and shareholder value to create for those who are able to win in the space. And so we do expect it to be competitive and continue to be competitive, but we are seeing a little bit of this leveling that’s happening. And it’s not speculative here. Our — one of our competitors was acquired and the commentary as of late was pretty explicit around what’s going on with that business. And we don’t think that’s an anomaly. We think that’s pretty much the norm for a lot of these paying for folks who never built the risk management parts of the business.
And our strong belief is that you got to have that piece to survive and thrive. And this is kind of our moment to shine because frankly, we’re well, well ahead of that.
Ramsey Clark El-Assal
And you touched on this a little bit, but talk about the entities, the state or the development stage of the industry in the U.S. maybe specifically meaning by not alter, is it still — to what degree is it still a white space out there at the consumer level? Maybe talk about where we’re at in terms of the market evolution in the U.S. specifically?
Yes. We would estimate that e-comm penetration is still got 2-plus turns of growth in the next 3 years. And so there’s plenty of growth in the industry, just in penetrating.
E-com, I’d characterize the off-line say that play as being extremely immature. I mean, even nascent like the product is almost non-existent in off-line sense, and we think that’s all greenfield for growth, which this is really the way of saying like, we think there’s a lot of growth.
And I think some of the investor sentiment as late as focusing on e-com trends or consumer trends, I think those are real trends that create headwinds or tailwinds on the margin. but they’re completely masked by the overall growth in the space. And so what matters for Affirm isn’t just the e-com growth, which is a factor and input to it. It isn’t just the consumer spending, it’s all those things and then there’s a multiplier against the overall growth and this is a payment method within those things and that’s taking share in such a way where we still have a lot of growth.
So we would estimate again that there’s several turns of growth just in the United States. And that’s so well below where we think the market could be at its full penetration. These things happen quickly, but they don’t happen overnight. I think some folks may even us thought that it would all happen overnight because of some of the COVID-related changes that caused the e-com boom to accelerate certain change. And certainly, we were the beneficiaries of that. But I think that if you look at just the absolute level of penetration where we’re at today, it’s still very small versus where most of us were predicted it.
Ramsey Clark El-Assal
Changing the topic a little bit here. Investors were understandably pretty pleased with the commentary on the earnings call about the path to profitability and the mid-2023 target. And I know you touched on this earlier in the earnings call, but help us think through the levers that you have in the business to kind of drive profitability?
Yes. So first of all, we were profitable in Q3. So our adjusted operating income was positive. And we actually had several quarters where that was the case over the past 1.5 years. I think admittedly, the — some of those other quarters benefited from provision-related tailwinds, provision releases from prior periods. And so it’s less about the underlying performance of the business and more around some over-provisioning that we did in and around COVID.
But this quarter didn’t have that. This quarter was about as straight down the mill as you could get with very few outliers and one times in the adjusted operating income line. It was just a really well-executed quarter that grew faster than our operating expenses. And I think this is such an unsatisfying answer for so many folks, but the truth is the path to profitability is grow your expenses lower than your margin growth and like we did that this quarter. And it’s not like we hit the pull hand breaks to do that. Frankly, it’s about moderating and timing investments.
This quarter saw us with slightly less human capital addition than frankly we wanted to, combined with the timing of some of our marketing campaigns slipping into Q4, our fiscal Q4, and that resulted in us being profitable. And so I don’t think we’re as far away as some folks maybe thought that we were going into the quarter. I think they were drawing lines with 1 data point, and they kept drawing it down for a long time.
And I don’t think we were ever that far away. What is true is that the first priority for us is to scale the network. The way we talk about it is that 3% to 4% margin number we’ve talked about, times GMV, that’s the amount that the expenses have to equal when we get to that tipping point. And therefore, more volume and scale makes the problem easier and you can scale into profitability quite quickly.
If you think about the specific points of leverage though, we do think there’s opportunity for us to provide some leverage on the G&A lines, obviously, on the sales and marketing lines given the nature of our marketing investments. Tech Data analytics will have less leverage because that’s an area we want to keep investing in. However, the truth is across the board for all of these, it’s just hard to keep up, right, having a hiring rate of 50% a year is really, really hard. Like, that’s actually a thing that’s difficult to sustain even if you wanted to and have the capacity to do it, it’s just really hard to do because the mechanics around hiring, training, onboarding and making productive that many humans is just difficult.
So some of this is natural leveraging of the human capital investments, and some of it is an acknowledgment that certain areas are going to leverage more quickly just because they are not areas where we want to invest like G&A.
Ramsey Clark El-Assal
I see. And you touched on provisioning. I think the provision expense increased a little bit versus the prior quarter. Walk us through what you’re seeing in your book and sort of the moving pieces here and your reserve assumptions? How are you guys thinking about extrapolating from what you’re seeing in terms of what you should be sort of reserving?
Yes. So as a reminder, we have an allowance for future expected losses where we adopted CECL and have had and will always have what we consider to be a pretty conservative view of this topic, which is we never want to be in a position to be — to not have that allowance in place. The commentary is most people adopt CECL and they see a big step up in their allowance, and that’s not what happened with the Affirm. And that’s because we’ve always kind of had this approach in our DNA and our blood about how we think about risk management.
So when we look at it, we start with the allowance, and we say, okay, well, for new originations or for the back book, what’s our current amount of expected losses. That was like $159 million in the ending of Q3. And we think about that in light of the unit economic. So how much for a given loan, how much expected credit losses there? And how is that compared to the revenue sources?
And when you look at the ILTC or the new economics this period, it was really strong, 4.7%, well above our 3% to 4% long-term range. And what that means is that we’re making credit — we’re making credit decision approval decisions in a manner that has a lot of capacity with respect to margin. And so feel like we’re at a spot where the credit box doesn’t need to take wholesale changes.
What is true is that we’re carefully monitoring and managing credit outcomes. We talk a lot about credit as a choice point for us. We pick the level of delinquency. We picked the level of loss in the business. And we pick it based upon unit economics, not to hit some vanity chart or to please an investor. We would do it to that make sure we print strong unit economics or generate assets with real value. And this quarter was a great proof point on that.
I think investors are so focused on trying to find these, I don’t know, signals in the static and the noise and they’re staring at the screen and everybody is moving around, and I appreciate the desire and sentiment, but we will always point you back towards our unit economics and say, look, if the level of provision still generates those unit economics, that’s the right trade-off. And that is the case for us right now and will be as far as we can see.
Ramsey Clark El-Assal
Great. Also a related question, on the balance sheet percentage of your portfolio funding mix was lower in the quarter. Talk about your long-term view there? Do you intend to keep reducing? Or how should we think about funding? I know there’s another one you talked about in issues. I’m sure you’ve talked about —
No, I love both these questions because I really do think that our story — this is on me and my team, our story is complicated, but some folks have grouped us with other people who had some hiccups lately, where I think they’re like apples and volcanos. They’re not even apples and oranges. I mean, there are different classes of things that people are comparing us to. And so other people ran to their balance sheet, we actually ran away from it. Oddly enough, had we executed our ABS transaction that we didn’t execute in the period, we would have had more on balance sheet, which blows people’s minds, but that’s because we have a really robust for lot program.
And this past quarter was an area where we did have slightly more. I don’t think that level of on versus off is something that I would want to sign up for a long term, nor would that level of efficiency be something we sign up for long term. where we had equity capital at around 2%. And yet, like you want to measure the durability of a funding program. It’s when all hell breaks out in some of these wholesale funding markets, and we print some of our best results. And that’s a testament to how we have designed our funding program is not reliant on any one thing happening and going our way. And that means that we can be thoughtful about how and where we engage.
We can onboard new partners and we can do it in really volatile times. And all of this is possible, not just because my capital team is the best in the world, and they are. It’s because we produce an exceptional asset. And the investors who understand it, whether you’re buying the debt and the ABS deal or you’re buying the whole loan, you understand that we generate and will continue to generate a quality asset. And in a lot of ways, these questions on credit are related to this, right?
So what happens is like if we tend to the shop and we produce a really high-quality asset, the capital is always there and the capital is really efficient for us, which in turn, we can turn to value for the merchant. And in this sense, we’ve created this very unique mouse trap where our performance on underwriting and our performance on credit really are inputs as we say. We make those decisions, and we make them because they’re important to the rest of the whole apparatus.
And yet, it was choppy. The market is pretty volatile out there right now between rates, recession fear and war. And in inflation, there is a lot going on right now that would cause even the most confident that investor to be worried about things. And I really do think it’s a testament to the quality of asset that we generate that we still have a very robust and committed set of capital partners.
Ramsey Clark El-Assal
Yes, that’s a great answer. I wanted to ask about the savings account product, which has an attractive interest rate on it. And is that something that eventually will become a funding source part of your funding mix? Is that in the back of your minds of that product? Or is that not that the wrong way to look at it?
No. It’s not the wrong way to look at it at some point maybe in their life. But in the near term, it’s not something we directly do anything with that product today exists for consumer engagement. And that product is partially funded by Affirm and partially funded by the bank partner who makes use of those deposits. We think that we’re proving something here for bank partner that there’s a real close loop between the same users’ willingness and ability to save and borrow.
And what’s fascinating to me is if you look at just that product, look at the people who use that product that’s a profitable business in its own, meaning that the people who are saving money with us are also borrowing from us. And we have a lot of really good active consumers in there with high lifetime value. And that is counterintuitive as I’ll get out. But I think it’s a reflection of just the kind of relationship that we have with these consumers. And it’s a marker on the depth and connecting it back to how we started the conversation, our mission is to improve lives through honest financial products.
Our mission is not to sell stuff. Our mission to not to outfit you and the latest fads and trends. Our mission is not to — we’ll do those things. That’s not the mission. The mission is about honest financial products. And I’m particularly proud that we’re encouraging some really good consumer behavior saving while these folks are still using our products to borrow and buy. And that’s a really healthy financial life to create a nest egg and still use good honest lending products when you need to get the things you want.
Ramsey Clark El-Assal
Give us an update on Debit Plus. How is that product rolling out? And then talk about it’s been a long wind up, but it’s a compelling product. So give us an update on how that’s going?
When we were — when we first went public between — about this time last year, I think the only question we got a question is 1 through 5, where it was Split Pay and Shopify. When is Shopify launching? When is that going to happen? When is it launching? When is it launching? When is it launching? Remember that. And we kept saying, “No, no worries, it’s on the horizon, it’s going to be here”. A lot of folks were like, but we want it now. And again, I think it’s a big disconnect between operators and Wall Street. These things do take time. But we’re really, really excited about it. We’re not at a spot where it’s fully rolled out yet. I’m not sure when we’re going to designate it such, but we’re in the process where lots of cards are getting mailed out. We’ve been in a few investor events over the past couple of days and I asked folks and the room still doesn’t have a lot of raise hands, people who have the card. So I guess it’s pretty early with respect to where the cards at.
What we’re seeing is a lot of great engagement for those who use it. We think that this is going to be the best way to repeat on Affirm, and we think that the consumers are really going to appreciate the features of paying for and eventually interest-bearing with the kind of certainty and control that a debit experience gives you all in a really cool and great app. We just got this completely unsolicited comment from a consumer who was gushing over the product and how she said it changed her life because the ability for her to manage our expenses kind of contained in a payment device like this was unique.
And I just — I’m so excited for what this will do for so many consumers. And for our repeat users, those who have a really good repayment history with us. I’m positive this is going to be a thing that allows them to separate out the decision around which piece of plastic to swipe from the financial product behind it. And the innovation sounds so simple and basic, but being able to separate those 2 things allows us to deliver this long, long list of really cool financial products to that consumer.
And again, in a way that really does improve the lives. And I think going into to a recession, if one is to happen, I can’t think of a better product to be able to be more closely associated with that consumer’s bank account, to be able to give them the right repeat tool, to allow them to do preapprovals before they take out a transaction. There’s so much goodness that happens for us and the consumer in those types.
Ramsey Clark El-Assal
I see. And so the — a good channel there, maybe not the primary channel is the cross-sell in the existing base. Your first target that your customers who are — you already know they’re good customers, and therefore, you can market them this product?
Yes. We don’t plan on opening it up to, we call it, new to Affirm for some time. That’s both expensive. Our business model has is pretty clever hack in that we don’t pay really anything for customer acquisition cost. Consumers are acquired at the point of sale, usually almost always on a profitable basis, meaning the “tax” are negative. We do pay some money on brand building. We do pay some money to try to reengage consumers. But not a lot of tech, and that’s just not our business model. Our business model isn’t take out a billboard to drive consumer adoption. Our business model is work with the best merchants in the world to create compelling financial offers. And so the initial distribution method is going to be for those who are currently live, active and in good standing with the Affirm.
And that — we have a lot on our plate. We have a lot to had to — we have a lot to work through just with that. And once we get there rolled out and we can talk about what additional acquisition might look like. But we’re going to start there.
Ramsey Clark El-Assal
Fantastic. Michael, we’re out of time. Thank you so much for joining us today. Really appreciate it. Great conversation.
Thank you so much.