Affirm Holdings, Inc. (AFRM) Earnings Call Transcript

Okay. Welcome to the DB Tech Conference. And now we have a fireside presentation for Michael Linford, the CFO of Affirm. I'm Bryan Keane. I cover the payments processors and IT services for Deutsche Bank. And so I'll go through a list of questions with Michael. [Operator Instructions] So with that, Mike, I guess, I'm going to give you MVP because you've been working all night with the earnings and then you're waking up early than more to be with us, but thanks for doing this.

Thank you for having me.

I guess before we get into the recent results from yesterday, kind of a theme from your earnings call was talk about unbundling the credit card, and Affirm announced an official rollout of Debit+. I know we announced that you were going to have a debit card, I think it was back in February, but now we have more details around Debit+. And it sounds like it will have the functionality of a debit card and also a credit card. So how would you describe the unique features of this card and how it will be used? Or it looks like it will still use the network rails, if I understand it correctly.

Yes. So first of all, we are really excited about this. In my 3 years here at Affirm, I've never had as much of a, I don't know, a vibe in the company for this product. It's in the hands of many Affirmers right now as we continue to test it and get it ready for launch later this year. So we're really excited about it. The one way to think about the card is, if you go out and get a card today, whether it's a debit card or a credit card, its features, financial features, are largely locked in to the actual card. So you'll get a card in the mail. You activate it. And then the financial product behind it is fixed. And you can change the APRs, you can do promotional work behind it if it's a credit card. But the debit card, it's just a debit card, it's like [ set to ] your bank account. And there's really nothing and no technology to kind of disaggregate the idea of a physical card and the financial product behind it. That's really what the debit card does. We don't consider it a credit card, but it is a payment device that allows you to do debit transactions, but will also support credit transactions. And that's the neatest thing about it, is it gives you the safety of a debit transaction experience, but still giving you access to borrowing, which is so important, as Max talked about in our call yesterday. These younger consumers who have seen the perils of credit cards have voted with their feet towards debit card usage, but they've limited their buying power. One of the real powerful things about the buy now pay later trend is we're extending buying power to consumers. And this is a great way to combine both of those 2 things, the delivery, physical world experience that's ubiquitous, and yes, it will ride one of the network rails.

Got it. And how will you guys get paid on this in this model?

We are -- we'll fill you in on some of the details of the product, its economics and everything at our event later this month, but we're not going to share any of that today.

Okay. All right. Great. What is your current funding mix between card volumes and ACH? And where do you see that mix going in the future? I know -- the question now is how much BNPL will really disintermediate the networks? I'm just trying to get to that sense on card volume versus ACH and where that might go in the future.

Yes. So to answer the question, we're roughly 40% ACH and 60% debit today. We have a small de minimis amount of credit card acceptance that we use in a very specific use case, but it's not material. And we, of course, want more ACH, and that's a little bit economic and a little bit strategic. Frankly, the more link toward the bank account, the stickier the relationship with the consumer is. And obviously, it's also a lot less expensive. But we would never steer a consumer to a one repayment mode or another. We kind of have the same approach to thinking about repayment as our merchants do about payment modes, which is we need to be very open to letting consumers repay us how they want to repay us. And the debit card is a pretty popular way to repay today. Clearly, with the debit card that we've been talking about launching, linking the bank account is a pretty important part of that process. And so we would expect that to be ACH predominantly.

Got it. I wanted to turn to the financial results. Obviously, GMV ex Peloton is accelerating. How much of the strength in the quarter is due from kind of the new wins, the Williams Sonomas, the DICK'S and Neiman Marcus? And then how much you shop versus the existing base? Just trying to get a mix of business for that growth.

Yes. It's a good question. So we talked about this on the call yesterday, but maybe some more color here. So merchants that were signed in fiscal year '21, so starting June -- July 1 of 2020 through June 30, so signed in year, delivered about 15% of fourth quarter GMV. So 85% of our result was for merchants or direct-to-consumer products that were live before the beginning of the fiscal year. And if you exclude Peloton, GMV for the merchants who were live for more than a year, think of this as our closest thing to a same-store sales measure, the growth rate was 92% for those merchants in Q4. So really tremendous growth on the installed base. It's a huge contributor. We also saw a [ 460 % ]growth in our virtual card product. We call it Affirm Anywhere. It's a direct-to-consumer virtual card that we issue directly in the app and ride Visa rails. So that product clearly contributed meaningfully to the growth rate as well, although it's not a material -- it's material, but it's not like a majority of our volume or anything. So the way to think about it is 15% is from those new merchants you mentioned, the 85% then breaks down between really strong growth rates in our existing merchant base and then healthy direct-to-consumer volumes.

And what about the travel and ticketing? How much mix is that contributing to the growth? I remember through the IPO process, we were talking about that being a big catalyst going in to 2020. And and then, obviously, the pandemic hit. But it felt like it's coming back. So just trying to get a sense of how much growth you're seeing there. And then how much further growth could there be when you get a full recovery in travel?

Yes. It's a really good question. So we talked about during the IPO that we had, we've estimated 10% of our GMV should be coming from travel. And you saw us kind of begin to approach that number in our fiscal Q2 and 3 net results. But by the time it hit fiscal Q4, it was actually 14% of our GMV. And I think that reflects 2 things. One is the travel rebound that did happen early was all leisure travel, which is really the consumer would be using our product. But also, I mean, I know like to me personally, all of us were anxious to get out, and so we certainly benefit from that early pop. I think it probably will settle down to being something more like 10% even at scale. And that isn't because travel isn't super growthful for us. In fact, we're really excited about the space. But we are also really strong elsewhere. So for the first time ever, our beauty and apparel category became our largest category. And the kind of growth that we see everywhere is the thing that keeps any one of these things from being too concentrated, especially for a category that has as much volatility as travel, where we went from being fully shut down a year ago to being wide open early summer to things being a little bit tighter today.

Wanted to ask about the mix of revenue because that came up a lot with investors'. Questions that I got is, there was a large amount of gain on sales and interest income versus maybe expectations. And then if you looked at the merchant network, that was a little bit below Street. And so I know this has a lot to do with the mix of business and how you guys think about it. So maybe you could help us think through this.

Yes. I mean the most important thing to stress, as I communicated yesterday to, the flow today, it's all mix based, okay? So let me just kind of paint for you the picture of products that we have. The strength of Affirm is that we are able to do any and all of these modes, okay? So what -- when people think of the NPL, they oftentimes think about that paying for interest-free product. Those typically have MDRs. First of all, the only revenues for us is MDRs or late fees. And of course, Affirm never charges late fees. And so our business model is MDRs, and they're kind of mid-single-digit MDRs, so kind of 3% to 5%, something in that context. And you can look to the pure plays and Afterpay, it does look at really good comparables there. So that revenue model is low to mid-single digits, mid-single digits in MDRs, and that's it. Then on the other end of the spectrum, you have interest-bearing loans. And those interest-bearing loans for us have slight premiums to interchange, 50 to 100 bps above interchange, but then, of course, have a tremendous amount of interest income that we either monetize by retaining on the balance sheet or selling the loans either to -- on a forward flow basis or in a nonconsolidated securitization. And there, the interest-bearing content is for merchants who frankly are competing away the interchange they want to pay to Visa and Mastercard and other issuers. And so for example, at Walmart, the income we make is predominantly from consumer interest or gain on sale, depending upon what we do with the loan. And then when they have the third mode, which has been the thing that has been deconcentrating for us over the past year, which is longer-term 0% loans, which have super high MDRs, right? So if we're stepping into, in the case of, say, room and board, a 24-month 0% loan, clearly, the merchant has to pay a healthy amount to compensate us for both the risk and the cost of funds that the debt cost there. And so if you think about those 3 modes I just talked about, one has total revenue of, call it, 4% to 5% in merchant fees only. One has north of 10% in interest income, either interest income or through gain-on-sale. And then the other has north of 10%, say, in merchant fees. And as those things mix across those 3 buckets, you get fundamentally different results in the income statement. And the key thing for us is, while it's really important, and we report that way because we have to, we don't manage the business that way. We're super agnostic as to how we get our economics. We care about making sure that we generate assets that have value, either because the merchant is paying for or the consumer will eventually pay us on a risk-adjusted basis, and then we can monetize it in the capital markets. And we're not really fussy about where it comes from. So it's really a long way to answer here, Bryan, for you. But when you look at those lines, you see the change in mix of the business, which for us, last quarter, we had a lot of great success in our direct-to-consumer product, which is an interest predominant product and it gets interchanged as well. We had a lot of success at Walmart. We had a lot of success at our travel merchants, which tend to fit more in the interest-bearing side of the world, just given the thin margin structures for most of the people in the travel vertical. And so there's -- when that mix happens, we're there to serve those consumers and those merchants, and it will show up as a different mix of content in our income statement. But what's important is it doesn't bother us. In fact, it's intentional, and we like that. Part of the secret sauce of Affirm is that we're able to do both of those things, and our competitors can't. And so we think there's just probably too much focus externally on that number. And frankly, we don't really manage it internally at all.

And just for modeling purposes, should that -- the mix that we've kind of saw, that trend of more gains and more interest income, is that probably the -- given the signings you've made, is that probably we're going to see more of that mix than the merchant side revenue?

Yes. It's really hard. We haven't given guidance there, and we're probably not going to. The 2 things that could affect it are, as we mix more towards more short-term, 0%, kind of split pay loans, paying for loans, you will see that revenue content look more like that. And so as the content moves to being more of that, which we guided to 10% to 15% of our business on a GMV basis this year being split pay, you would expect that to be predominantly merchant fees. There's a little bit of in our team accounting thing where some of those merchant fees show up as interest income, which I will not bore your customers with that this morning. But aside from that, and in terms of the commercial model, it's all merchant fee. And that will mix up higher in our business, and that will have kind of one first-order effect. But the second first order effect is the deconcentration out of things like Peloton and other long-term 0% programs, which will lean more towards interest income and gain on sale. But it's -- I just -- I want to be clear, if we have more success in the split pay world, it will actually not show up that way. It will just show up as higher velocity GMV with less revenue, still very strong unit economics, but not interest income and gain on sale.

Yes. So the guidance assumes about 10% to 15% of GMV in fiscal year '22 will come from split pay, and over half of that is from Shop. Can you just explain the Shop on-boarding process? And then if I understand it correctly, there's kind of a big push from Shop to now get Affirm ramped up. And so it's kind of an opt-in program. So I guess, I would assume that there'd be a massive amount of new merchant count just in this quarter from Shop unless the merchant will opt out, if I understand it correctly.

Yes. So the first point of the question on what's the on-boarding process, that was what so much of the design work was really around. I mean, we focused a lot on the consumer experience but also the merchant experience. You have to think about the long tail at Shopify as being people who need just as much design and user experience work done as a consumer because these aren't large enterprises with heavy configurations. These are small businesses, and sometimes, extremely small, maybe 1 or 2 people in the entire business. And there, you need to make it super easy. So it is. If you are a Shopify merchant, you can onboard Shop Pay Installments with the matter of a few [ bucketloads ]. So we're -- that's very easy. There is obviously 2 important things to think about. One is they do have to accept our terms. And so we are in need of the merchants agreeing to the program, both in terms of the pricing as well as other terms and conditions. And then the other is, look, sometimes, a lot of these Shopify merchants, they're not attending to their business every day. And they may do very low volume over the course of any quarter or a year. And then again, that's the power and magic of Shopify. It's a lot of small merchants. There's a few large ones, but there's a lot of very long tail, which gives the strong sense of ubiquity and distribution that we're so excited about. We disclosed the active merchant count number. We -- it doesn't take a lot of imagination to realize a lot of that comes from Shopify just given the nonlinear growth there. Some of it also came from our own work on merchant self service and the like, but Shopify is a big part of that. And then we disclosed that we're -- have onboarded on to hundreds of thousands of merchants. And that number is always going to be bigger because it being available on the site before it, it actually experienced the transaction as a common modality. And so we would expect continued merchant ramp from Shopify. And again, we'll update you guys when we do our first quarter results.

Great. I know you're not sharing a lot of details, but what can you share on the Amazon partnership, which -- I don't think you guys have put in the guidance, but I know you're testing today. What details can you give us on that?

Yes. The short and, unfortunately, quite glib answer is what I can share with you is what we shared in our press release and our 8-K, which is we are testing with select customers on Amazon right now, and it's a nonexclusive relationship. And that's all we can really share about the partnership. Now what I can talk about, though, is just how we view it. And it's just a really cool moment for the company. Our strategy over the past 3 years has really been to focus on the highest points of leverage and the largest distribution. And so we started by securing Walmart. That was a merchant that we signed in 2018. And that was a big seminal moment for Affirm because it was the first time anybody of real scale and size that, this thing is interesting enough that I'd like to put it alongside my store card. And that was a big deal. And even more history there is at the time, Walmart was moving away from its deferred interest program that Synchrony had because it realized the toxicity of that product and what it was doing to its consumers. And so we had the -- a big moment for us. And then last year, we announced the Shopify relationship, which for us was kind of the second big belt really there. And we were really excited about the distribution opportunity there, the technology orientation and the scale that Shopify would bring to us. And to be able to partner with Amazon in any context, exclusive or not, is just a really exciting moment to get access to well over $300 billion in GMV and just obviously a force in the e-com. And if you think about our goal to be ubiquitous, it can't be ubiquitous without being distributed by the largest platforms and retailers. And so from our standpoint, it's all super exciting. And we have to go earn it every day. It's not something that we have a lot of certainty on. We're not giving the guidance because we're sandbagging. We're not giving guidance because we're early. We're testing right now, but we're just excited for what it could be.

Great. I wanted to move to revenue minus transaction expense or less transaction expense, contribution take rate. I think it was 5.9% in the quarter. It's been kind of hovering higher, I think, than you guys originally anticipated. And then there's some take rate moderation in the first quarter. And then if you kind of do the math, it looks like almost 4.5% for the full year. So maybe you can take us through on take rate, kind of where we are today and kind of how you see it trending, not only this year in the first quarter, but going forward as well.

Yes. So we benefited quite a bit over the past couple of quarters as we have continued to have excellent credit performance and continued to be able to reduce our allowance as a percentage of loans held, which in turn has an outsized impact, obviously, on the in-period provision. Additionally, as we've mixed away from long-term 0% loans, we have less loss on loan purchase commitment. And that's certainly reflected in our guide as we don't take that initial hit associated with buying loans below market value from our bank partner. But then, more broadly if you think about where we're headed, we're in a really benign environment with probably the best credit market you can imagine. We did several securitizations over the past year. The most recent revolving securitization had a 24-month term. We were able to advance 99% of the consumer balance, and we are paying less than 1.3% on a fixed cost basis. And those kind of terms are just phenomenally good for the kind of asset we're creating that does have on the interest-bearing side, call it, 15 to 20 points of after loss interest yield on it. And so you've got a really viable asset and you've got extremely attractive cost of financing. And that -- it's a perfect storm in terms of creating a really strong moment of profitability. We also have a big mix of our business right now that is in an interest-bearing mode. As we continue to grow our split pay business, if you think about MDRs in that space, I mentioned they're kind of 4% to 5% in that context. You can't have 4.5% margins on a 4% revenue business. So those margins will come down as we mix into that space. And we like that asset a lot. It's kind of high velocity. It's super great on engagement and acquisition from consumers. So we love that asset, but it clearly won't be yielding the same on a percentage basis. And so both of those things are what lead us to say, look, yes, I know we're running a little bit warmer than we guided to you before. But know that we still believe in the long run, things will moderate down that 3% to 3.5% range.

In the merchant acquiring money model, all the money is made in SMB. So the question I often get is, how profitable can these large contracts be with Walmart, Amazon and Shopify? Because typically, it's hard to make money on those large merchants.