2023-06-08 17:45:22 ET
Affirm Holdings, Inc. (AFRM)
Bank of America 2023 Global Technology Conference
June 8, 2023 13:40 PM ET
Company Participants
Michael Linford - Chief Financial Officer
Conference Call Participants
Jason Kupferberg - Bank of America
Presentation
Jason Kupferberg
Hi everyone. I'm Jason Kupferberg, the payments, processors and IT services analyst here at Bank of America. We're very excited again. As was the case last year we have Michael Linford, CFO of Affirm with us. Lots of grounds to cover. We've got 30 minutes. Thanks for being here as always. We appreciate it.
Michael Linford
Thank you for having me.
Question-and-Answer Session
Q - Jason Kupferberg
Of course, I wanted to give you a chance to maybe first talk about you've had a couple of press releases the last two days, one was about Amazon Pay and Affirm becoming an available instrument in that wallet and then today about the authorization to buy back the convert. So maybe if you want to just hit on both of those to give us your perspective on what investors should really appreciate from those announcements?
Michael Linford
Yes. I mean, I think it's just more of what we've been working on here at Affirm. We laid out our -- starting with the convert, we laid out our capital priorities in the shareholder letter a few quarters ago.
You saw us last quarter chip away at it and we continue to look at that as a smart thing that we can do for the shareholder to manage that liability proactively. We've been running with a pretty strong amount of what we call dry powder not out of gap term, but its how we think about a view into liquidity in the business.
And we have a pretty strong position there and we obviously have a lot of conviction for what we're building and think that practically managing that liability is a smart thing for the shareholder. And so it's tactically a smart thing for us to do and the feedback we get from convert investors we talked to suggest that that they would also receive that pretty well.
With respect to Amazon and the Amazon Pay announcement, again, it's more of what we've been working on with them. We talk a lot about the pride we have in being able to work with a world class retail institution like Amazon and we talk about the depth of relationship and how we work together to solve problems for consumers.
And I think the outside world wants to look at the contract and current -- and all those things and internally that's just not a thing. We're focused on making sure we can expand our offerings to as many consumers as possible, being able to get off of Amazom.com and support other merchants is exciting to us, finding more avenues of distribution for our product.
We talk about the 60% of U.S. e-commerce that Affirm is available on. It's a good news, bad news thing where 60% is a great number, but its 40 point short of 100. And so one of the ways we get that 100 is we find ways to get our product distributed with partners who understand what we do for consumers and can offer that product proudly. And we're very excited to continue to do that. And I think it's more than anything in testament to the continued work we're doing with Amazon on behalf of merchants and consumers all over the world?
Jason Kupferberg
So merchants who currently accept Amazon Pay as a form of payment would basically have the option to add Affirm as a payment method, right, that's essentially how it will work?
Michael Linford
That's it.
Jason Kupferberg
Okay.
Michael Linford
And it's obviously super important because it's with the world leading largest retailer, but also -- online retailer, but also its part of our consistent strategy to find ways to get distribution and we're excited to get back to talking about those parts in our business especially since that's always remained what we're focused on.
Jason Kupferberg
Yes. Do you think it moves the needle on GMV in fiscal 2024?
Michael Linford
I think it's important, but it's important like all of the things are important.
Jason Kupferberg
Right. And then collectively, they all add up. Right?
Michael Linford
Yeah. I mean, one of the things that's I think underappreciated a little bit is just how important the full distribution is for things like repeat rates. So for consumers who use a product once are delighted by it, they actually have to have an opportunity to see it again for them to use it again. And while we have a strong and a lot of opportunity in our direct to consumer business, the ways we can drive those real network effects that we see in our business, they're tethered to the distribution.
It's part of the reason we're so excited to have the partnerships we do with the world's largest e-commerce players. But in the words of one of my former executives more is more. And so we're definitely focused on getting more distribution.
Jason Kupferberg
Okay. Affirm has a really good lens into consumer, discretionary spending, younger -- call it maybe lower to middle income kind of cohort. Just curious what you've sort of seen from that cohort as the quarter has progressed just given all the moving parts and uncertainty in the macro, which you may have read a little bit about.
Michael Linford
Yes. In Max's shareholder letter, he talks about all of the unprecedented events that have happened over the past couple of months and the joke internally is we're just waiting for the alien invasion as the next thing that none of it had in their radar.
Jason Kupferberg
Right.
Michael Linford
And it feels almost that fictional that the number of things that have happened. We've been experiencing an unprecedented rise in rates and associated macro response to that. You've seen banking failures both as a result of that, but also I think as a result of taking the eye off the ball a little bit on some basic risk management practices. And that like – that's a lot of volatility. All – and with the consumer who's feeling the pressure of inflation, but maintaining really strong employment. And for us, it's really the same -- it's more of what we've been seeing throughout the beginning part of this calendar year, which is the consumer has clearly changed their financial situation from where they were a year and two years ago, but the resiliency and employment has really allowed them to continue to be really performing on credit, our delinquency trends, both what we report for the portfolio, but also our trends you see in our ABS data remain really strong. And that's because we believe the consumer is fully employed and we're able to identify and price risk correctly in this environment.
And we think we'll continue. We've stopped internally talking about the change in credit outcomes we saw about this time last year as a stress, we use the word stress a lot, but it's no longer stress. It's just the norm has been reset and we're running the business at those levels. And you're still seeing the same trends with I think some green shoots, but the same trends around the shift away from larger discretionary purchases and towards basic Staples. That's obviously a trend that consumer is experiencing going through. And yet, talking some folks earlier that the strength in sectors like travel remains really strong. And that's in large part because a lot of deferred travel that folks had been pushing out and we expect that to continue to be strong for us for the foreseeable future.
Jason Kupferberg
Maybe we can just reflecting back on March quarter performance a bit, revenue GMV, you had a pretty nice beat and raise there. In fact, I think you raised guidance for this fiscal year by more than what you beat the quarter by. Revenue less transaction expense, there were some other dynamics going on, right? And I think that that the beat didn't quite flow through. And so maybe just for the benefit of everyone walk through some of the -- there's some funding mix considerations and so forth. But maybe you can kind of lay that out and walk us through the pieces?
Michael Linford
Yes, we're really excited for what we feel is both pockets of reacceleration of GMV growth, increased consumer engagement. We're excited for things like our Debit+ program and where they're going to go, all of which has us feeling a lot more excited about the growth prospects in the near term. We have always had excitement about the long term prospects, but we knew that we were having to manage through a tight window here and feeling really front footed there.
And yet the capital markets remain extremely difficult to navigate right now. The team that we have doing the work is the best team in the industry. I was speaking to them yesterday. And I say it a lot and I believe it we're really good at this. And yet the market remains a difficult one to operate in. You have the combination of higher rates, which has been discussed ad nauseam, and I would encourage folks to go back actually to the last time you and I are together on stage. We talked a lot about the rate environment and I believe the then forward curve expectation of rates with something on the order of 200 basis points. We all think that's acute now. And we forget how quickly it's changed a year and a few months later. We're in a very different universe. But alongside that, credit spreads have also widened and they widened not for us specifically, but across almost all asset classes.
And that's really because a combination of making sure that the premium is appropriate for the risk that they're taking, but also a general sense of credit uncertainty that's out there. And I would speculate, I guess, shared opinion that I think when you have multiple large banking failures, it doesn't do good for credit committees thinking about risk that they want to take.
And that's not a specific thing to us, right? But that backdrop makes it a difficult environment to operate in. And so what does that mean for us? For us, it means that we're going to continue to use funding strategies like our warehouse lines and consolidated ABS deals, it means that we're going to have less growth in our forward flow program. And that does change the shape of the P&L in a given period. But I think it's important to separate that from the asset that we're creating. Think about our model as we create an asset and then we fund it. The asset we're creating continues to get more value in it. We've been excellent on credit outcomes over the past couple of quarters. I think our credit performance stands out in high contrast to almost any other unsecured consumer risk taking institution.
And I think our while our funding costs are going up so is our ability to price and our efforts on alleviating some of the APR caps that we have for our merchants has allowed us to continue to earn enough revenue to offset that.
So we feel really good about the asset that we're creating. So we think about the return on that asset, the economic content that you get. Feel really good about it. And yet the shape of the P&L and the funding strategy is going to vary a little bit.
And then lastly, like look, we're any quarter that you expect to see a sequential growth in GMV like we're forecasting for our fourth quarter you do expect there to be a little bit of this lag effect because of the timing of how we earn and report out those revenue less transaction cost numbers. It's heavily influenced by the timing of the growth in GMV. And so you saw that play out. Our Q3 results were really strong.
They were really strong in part because we had a really strong Q2 that showed up down the P&L in Q3. And so you would see the same thing play out where the Q2 results I think folks were concerned with, but the Q3 results were stronger. And I think you're going to see Q4 sequential growth in GMV, which is going to suppress a little bit where Q4 is going to be, but it's going to create value for the P&L throughout the course of next fiscal year.
Jason Kupferberg
Okay. So let me maybe pick up on that with revenue less transaction costs since it's obviously very closely watched metric. And you guys have been very consistent since the time of the IPO, you've said 3% to 4%, 3% to 4% and you went above it obviously during the pandemic, right? And you told us all it was going to normalize and you were right to normalize. Looking forward, I think you've continued to say with a high degree of conviction, you can operate in that range in pretty much any macro scenario.
So just like a little two part question like a, what sort of gives you that confidence and visibility to stay in that range and then b, just hypothetically if you were to fall below that range, what would be the most likely reason for that to happen?
Michael Linford
Yes. So thank you. And I think we have been consistent.
Jason Kupferberg
You have.
Michael Linford
And when we were running at 4.5%, I got the question of shouldn't it be higher? And we said, no, no, 3% or 4% is a good number. And we've had had quarters and we would expect to have quarters that may dip below that number. And maybe even period of time where you're on the lower end of that. But that doesn't take away from what we think is like the fundamentals there. And the fundamentals are that we produce an asset that's really valuable. And we have a lot of levers at our disposal to generate the level of unit economics that we need to build a profitable high cash flow business, which is what we're all about.
The biggest drivers in terms of like one quarter swinging up and down is really around the balance sheet strategy. And so as you think about less gain on sale and more loans on the balance sheet with the provision for credit losses happening at the time as loans go to the balance sheet you think about earning the interest income over the life of the loan, it just creates the skew, you have lot of cost upfront, no revenue upfront and a lot of revenue happening later.
And this is a thing you saw in our second fiscal quarter and it's a thing you should expect to see in Q2s probably for the foreseeable future where second quarter is going to have a lot of origination serving in Black Friday and through December, end of quarter originations which amplifies the effect even more alongside of sequentially growing quarter, which amplifies the effect again.
And then you layer balance sheet usage on top of that and you get this vertical P&L the actual P&L report in the quarter as being very different than the quality of the asset that you produce. And when you're able to sell more of your production to fore and flow partners, all those dynamics go away, you produce an asset, you sell it, you book your gain and you go on the next quarter.
Those dynamics really do factor in heavily on your balance strategy. So quarter to quarter, that's the biggest driver. If you think about over the longer term biggest driver why we wouldn't be at 3% to 4% is a mix in our business. And so we talk about 3% to 4% as being a function of having some businesses like our monthly installment products that can be more like 4% to 5% and some businesses like our paying in four business being 1% to 2% and they average out to 3% to 4% obviously if we mix more towards higher velocity, paying four businesses, you'd expect that number to be lower.
Additionally, we've talked a lot about how Debit+ will change the math and we're going to do some work to communicate how we think about Debit+ GMV, the PayNow GMV, which we do not expect to be anywhere near 3% to 4% on a margin standpoint given that the PayNow GMV is maybe has a point of revenue on it, 3% margins aren't possible on that.
Jason Kupferberg
Right, right. So why don't we go to Debit+ arguably your most prominent new product right now. It sounds like it's kind of ready for prime time as we go into fiscal 2024. Just walk through the value proposition for the consumer, for the merchant, maybe any kind of update on this kind of initial rollout that's been proceeding in the last couple of quarters and how will the investment community be able to track the progress of Debit+?
Michael Linford
Yes, we are so excited about this product. And that's the thing that I know we've been saying for some time.
Jason Kupferberg
Max has been saying for some time.
Michael Linford
Max has been saying for some time.
Jason Kupferberg
But now you're joining the chorus.
Michael Linford
I am now very much in the same camp for the excitement. Let me talk about it for why it matters to the network that we're building, why it matters to consumers and why it actually is a cool thing for merchants as well.
So why it matters to our network? Today, we primarily serve considered purchases online. And so we have a frequency that while it's growing in a really healthy clip is well south of the kind of engagement that you'd expect with kind of primary payment methods that consumers use. And so we know our frequency is not where we want to be and we want to continue to focus on that.
Our network also doesn't extend itself easily offline. So while you can use Affirm offline, we sure make it difficult for the consumer to do so. And by giving the consumer a try and true payment method that doesn't require apps and barcodes and clogging up the checkout line as you fill out your Affirm request. You give them payment method that is truly seamless to the physical world experience, which is tapping that NFC chip or swiping a card. That opportunity for us and the unlock for us is huge.
We talked about why distribution opportunities like Amazon Pay are so exciting to us. So is getting our product into the physical world easily. That's obviously an asymmetric large portion of retail generally. It's also an area that's benefiting from the post COVID resetting and normalization of online, offline trends and our product means just as much to consumers in that mode.
And so for frequency, for offline engagement, we just think it's really compelling. It's also the best way to use Affirm. I'm obviously a heavy user of it. So most of the management team as we like to make sure we use all products a whole lot. And it's a substantially better way to use the product because you separate out the need for using the app from the actual last mile and it's a great experience. So that's why it matters to us and why we're so focused on it.
For the consumer, they get to take the purchasing power that we give them transaction level purchasing power that we give them. And apply it to a much wider set of transactions with almost no friction.
We have a product today we refer to as our direct to consumer virtual card product. Actually we call internally, but that's what we talk about it externally. And what that product is, is you open up our app, you apply for a loan, a purchase amount, we go through all the process, we create the loan, we then generate a one-time use virtual card number. And then we do something that is so friction full. We ask the consumer to copy the card number, the expiration date, and the three digit code into the checkout flow online.
In the store, if NFC is working, you can use it with some of the digital wallets, but sometimes the cashier has to type in the number. And like each of those steps are terrible. And all of that just disappears. When consumers talk about the card and why it’s so powerful is it's everything Affirm does for them delivered in a form factor that it's just easy to use. And that's really exciting.
And it's more than just one of those things. Right? So it is the payment method that you can use as your debit card for your groceries and your cups of coffee that you wouldn't ordinarily want any purchasing power expanded with. But it's also the card that you can use to get purchasing power. And you can do it in a way without revolving.
Remember The thing that the consumer gets very quickly about the product that I think investors are slower to get because we live on the coasts and generally aren't the profile of users who are revolving on credit accounts, they do not want to revolve. They love the control that they get out of transaction level credit and that to them is a huge important feature. And we're giving them the things that they love about that while it's still being a very easy to use everyday use card for the daily transactions.
Consumers love it for that reason. We can extend the purchasing power in more modes for them and we can take out a lot of friction for them. Merchant, so love the product because it requires no integration work for them. And every merchant invariably wants us to create a solution for in store. And then you start to get into all the complexities of the how. And that can show up as like something as simple as just a sticker on the checkout wall and say, go download the app and then generate a virtual card and all that friction I mentioned comes back and is in play and you're jamming up the checkout line or you can generate a QR code and have it be scanned by the register. It requires a huge technical lift from everybody involved and oftentimes also jams up the line because the consumer still has the application as seamless as it is. It takes time. It takes all of that away.
We can talk to somebody in a marketing department who wants to offer a pay in for product in the store and can't get prioritized in the technology roadmap. And that merchant and we can be live --
Jason Kupferberg
You've done already.
Michael Linford
Yes, you can market the product, you can tell consumers, we can go help them understand that we can deliver the cool features of buy now pay later, paying for monthly installments, you name it and requires really no lift for them. And so it's about being able to give consumers what they need to be able to purchase what they want without having to, frankly, fight for IT resource which is actually a really hard thing for the larger enterprises who are most concerned with the online to offline trends yes.
Jason Kupferberg
Okay. So when you guys give fiscal 2024 guidance, will there be kind of a carve out for Debit+?
Michael Linford
I'm not going to make any promises about fiscal 2024 or guidance or otherwise at this point. What I will say is we've been consistent, we want to help investors understand what -- the relative contribution. We want to help investors understand how important the PayNow piece is.
I think for the portion of the card that lending. Like today, we don't break out that direct to consumer virtual card product even though it's a very big business for us. It's also a business that's been accelerating for us. We don't break that out and I'm not sure that we will for the card. I'm not sure about that yet, but I do know we'll tell you for the debit portion. Give you some sense of how much of that pay, we call it PayNow, but the stuff that is on the card only for 24 or 48 hours, And it's really important because coming back to your question around the revenue less transaction costs, we need to make sure people understand the impact that that has on the number, which obviously will drag it down and we don't think is to be painfully repetitive, our 3% to 4% range did not include PayNow business in that range.
Jason Kupferberg
Okay. Okay, got it. So basically the consumer is going to essentially be linked back to whatever their existing checking account is with this Visa branded card.
Michael Linford
Yes. Sorry I missed that.
Jason Kupferberg
No, it's okay. No, I just want to make sure.
Michael Linford
Yes, no, I really appreciate that. Thank you. I missed that. Other piece that's really cool for the consumer is we're asking them to change their account. They certainly can open a savings account with Affirm today and we would love that. But we don't make that a requirement. It's not a requirement to have an Affirm demand account in order to use this product.
And that today looks like either we call it linked and unlinked you can have your account linked to the card in which we can offer you more product and features. You can also operate unlinked which still just delivered that same credit product that we have in the app in a physical form factor.
And so while actually compelling is we're asking the consumers to like change their whole financial life. We're asking them to begin to use the financial product that we think sits on top of and leverages their existing financial life and you have a checking account with large money center bank, great. Keep it. So you don't need to change that.
Jason Kupferberg
Right. So easy for consumer is easy for merchants. Okay. Right before we started this year now, we're talking the P word, profitability, it's becoming more prominent to use another P word. And you've talked for a while now about achieving, sustainable positive adjusted operating income, really, I guess, exiting this month, right, which is the end of your fiscal 2023.
So you clearly seem on track to do that, but can you give everyone a sense of how you're just broadly thinking about the longer term potential trajectory of adjusted operating income margin.
Michael Linford
Yes, it is upon us. We've had several quarters in our history where we've had brief moments of adjusted operating income positivity. And the real focus on us right now is making sure that we're getting our operating expenses levered appropriately with the growth and revenue in the business so that we can do that on a sustainable basis. And we're happy with the progress that we're making and there's no sense that the work is done.
We very much have a lot of work to do to live up to that commitment that we've made. And so the team is focused on it and will remain focused on it. From there, we haven't made any commitments as to how we think about profitability trending from that point. And certainly not going to today.
But then we can begin to talk about how we think about investments in a slightly more rational way. So if you think about our history over 4.5 years I've been here, we've always been invested well ahead of the business. And we really didn't take a lot of time to think about what is the level of profitability that we want to reinvest in the business because we were obviously running at a negative operating margin for most of our time.
And so what I think we'd like to do is think about paying the profitability and getting to thinking about what level of investment makes sense? How do we think about these specific opportunities that we want to invest some of that? Positive margin into? And what do we think is important for us to continue to grow for the shareholder?
We're not interested and giving up on the opportunities there in front of us. So you're going to see us continue to want to invest a healthy portion of this. Because we think the opportunity set remains really big. And so we're going to want to create space for that, but we're also going to want to be mindful of showing investors that we say we have confidence in the long term operating margins of this business and its cash flow generation profile at scale.
We want to make sure we're giving investors enough confidence of that path is something that we're actually on and is it just something we believe.
Jason Kupferberg
Okay. That makes sense. We've been getting some more questions about with student loan repayments starting back up pretty soon here. I'm sure you guys have been thinking about that, do you anticipate any material impact either on GMV or delinquencies?
Michael Linford
So we're not currently very focused on the first order impact that it's going to have with us.
Jason Kupferberg
Okay.
Michael Linford
We feel really good about our ability to control credit. We think that things happen. They definitely could impact after anybody and we need to react to it. But given the short duration of our asset, we're not sitting here saying let's tune the decisions today for a thing that might happen in the future. We can be a lot closer into. And that being said, I do think it is -- it's on our list of things that we're looking at from a macro standpoint that that we're paying close attention to. The consumer remains fully employed today and healthy in that respect despite some of the pressures on them. But it's not so perfect that they couldn't withstand any shock. And so we're mindful of what impact may have in the consumer more broadly and we're certainly going to take that into consideration and how we run the business going forward.
Jason Kupferberg
All right. With that, we're out of time. Thank you, Mike. I appreciate it.
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Affirm Holdings, Inc. (AFRM) Bank of America 2023 Global Technology Conference Transcript